Limitations to the Non-Recognition Rules for Asset Transfers to Foreign Corporations

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Are you thinking of transferring appreciated property to a foreign corporation in order to utilize the corporate “non-recognition” rules, and to possibly avoid further US taxes? You should be aware that while in certain circumstances it is feasible to transfer such property in order to properly run a business, there are many limitations placed upon the ability of US persons to do so when transfers to foreign corporations are involved. This article will briefly explain these limitations under section 367, and its subsections.

The Corporate Non-Recognition Rules

Under the IRS non-recognition rules, C corporations can generally avoid taxation on certain transfers of appreciated property when a corporation is formed (IRC section 351), reorganized (IRC sections 354, 355, or IRC 361), or liquidated (IRC section 332). These rules thus constitute an exception to the general corporate tax rule that sales or exchanges of property by taxpayers is a taxable event.

However, the corporate non-recognition rules are limited under IRC Section 367 when property is transferred by or to foreign corporations.

IRC Section 367

IRC Section 367 was enacted in order to prevent US taxpayers from avoiding US taxes by transferring assets to controlled foreign corporations when such an entity is formed, reorganized, or liquidated under the corporate non-recognition provisions. The section specifies that a foreign entity will not be considered to be a “corporation” for the purposes of IRC Sections 332, 351, 354, 356, and 361.

The following paragraphs will briefly describe some of the subsections of section 367.

IRC Section 367(a)

Section 367(a) limits the ability of US persons to transfer appreciated property (such as stock, assets, or certain other property) to foreign corporations in a corporate reorganization to avoid US taxes, and then sell the appreciated property outside of the U.S. tax jurisdiction. Unless a transferor qualifies for an exception, section 367(a) generally treats an exchange of certain property (under sections 351, 354, 356 or 361) by a U.S. person to a foreign corporation as a taxable exchange. These exchanges are commonly termed as “outbound transfers”.

The IRC generally grants an exception to outbound transfers of assets (other than stock) if the assets are to be used in the active conduct of a trade or business outside the United States.

IRC Section 367(b)

IRC section 367(b) is primarily intended to monitor the earnings and profits of a controlled foreign corporation. The subsection IRC provides that, “[I]n the case of any exchange described in IRC sections 332, 351, 354, 355, 356 or 361 in connection with which there is no transfer of property described in IRC section 367(a)(1), a foreign corporation shall be considered to be a corporation except to the extent provided in regulations prescribed by the Secretary which are necessary or appropriate to prevent the avoidance of Federal income taxes”. Additionally, there are proposed regulations under this section addressing the carryover of earnings and profits and taxes.

IRC Section 367(d)

Outbound transfers of intangible assets are covered under subsection 367(d), and not the more general subsection 367(a). Under this subsection, if a U.S. person transfers an intangible asset to a foreign corporation (in an exchange described in IRC section 351 or 361), the tax effect is to treat the intangible asset as having been exchanged for contingent (royalty) payments. The contingent payments (for a period of no more than 20 years) must be commensurate with the income attributable to the intangible transferred.

US persons subject to this subsection must report the exchange in accordance with IRC section 6038B, or be subject to penalties, as well as an extended statute of limitations under IRC section 6501(c)(8).

IRC Section 367(e)

Under Section 367(e), if a US corporation distributes the stock of a foreign corporation to a foreign person in a distribution described in IRC section 355 (“Distribution of stock and securities of a controlled corporation”), gain on the distribution will be taxable to the distributing corporation under IRC section 367(e)(1); however, the distribution of the stock of a domestic corporation by a US corporation to a foreign person under section 355 would not generally be taxable under IRC Section 367(e). The tax liability of the foreign person is unaffected by this section.

Furthermore, under IRC section 367(e)(2), if a U.S. corporation is liquidated into a foreign parent corporation under IRC section 332, the U.S. corporation will be treated as if it sold its assets in a taxable transaction (i.e. IRC section 337(a) and (b)(1) will not be applicable), except as provided by regulations.

Additional Related Reporting Requirements

It is important to remember that IRC Section 367 requires various IRS reporting requirements, collectively known as “367 Notices”. Moreover, certain outbound transfers by U.S. persons may require the filing of Form 926. Other IRS reporting requirements may apply depending on your particular fact pattern.

Contact Sherayzen Law Office for Legal Help With Transferring of Appreciated Property to Foreign Corporations

This article provides only a very general overview of the IRC Section 367; however, the subject matter is much more complex and depends on constantly changing IRS regulations. Therefore, this article does not offer legal advice and should NOT be relied upon in determining your particular tax situation.

If you (or the entities that you control or partially-own) are planning on transferring tangible and intangible property to a foreign entity, contact Sherayzen Law Office for professional legal assistance in this obscure and highly complicated international tax matter. Our experienced international tax firm will guide you through the complex web of international tax rules in order to best structure your international business and tax transactions as well as help you comply with the numerous relevant IRS reporting requirements.

Current Basic Estate and Gift Tax Rules

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With the new year upon us, it’s a good time to review the federal estate and gift tax rules in order to utilize them to their maximum effect. Taxpayers should also be aware that certain beneficial gift and estate tax laws may expire at the end of this year and revert back to the pre-Economic Growth and Tax Relief Reconciliation Act of 2001 laws if Congress does not extend them, so taxpayers may also want to consider this when making decisions. This article will briefly explain some of the most basic current federal estate and gift tax rules, and highlight some of the laws that may sunset at the end of 2012.

Unified Federal Estate and Gift Tax Exemption

The unified federal estate and gift tax exemption for estates of individuals who die in 2012, or who make gifts this year is $5.12 million per spouse. For 2011, the unified federal estate and gift tax exemption was $5 million per spouse.

If Congress does not extend the unified gift and estate tax exemption, it will automatically be reduced to $1 million beginning 2013. Taxpayers who may be subject to gift and estate taxes at such levels should thus take heed.

Federal Estate and Gift Tax Rates

Currently, both the estate and gift tax rates are a flat 35%. If Congress does not extend these rates, the estate tax rates will begin at 41%, and reach a maximum of 60% in certain cases (55% top rate plus a 5% surcharge on estates over a statutory amount), and the gift tax will have a maximum 55% rate. The Generation-Skipping Transfer (GST) tax rate will also revert to a 55% rate (up from the current 35% rate).

Portable Exemptions

Under current tax law, surviving spouses of married individuals who die in 2011 or 2012 may use federal estate and gift tax exemptions that their spouses did not take during their lives. However, the ability of taxpayers to use portable exemptions will also sunset at the end of this year if Congress does not extend them. Thus, taxpayers who may be facing estate and/or gift taxes may want to keep this in mind when planning if such unfortunate events occur.

Contact Sherayzen Law Office For Help With Your Estate and Tax Planning

Obviously, this article only provides a very small amount of some of the basic gift and estate tax rules currently in place. It does not offer any type of legal advice and should not be relied upon in determining your particular tax position. Please contact our experienced tax office for legal help with your estate and tax planning.

Last Estimated Tax Payments for the Tax Year 2011 are Due on January 17, 2012

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Estimated tax payments for the fourth-quarter of 2011 are due on January 17, 2012. The estimated tax payments should be made using Form 1040-ES. Note, if the due date for an estimated tax payment falls on a Saturday, Sunday, or legal holiday, the payment will be considered on time if it is made on the next business day.

This is the last chance to make the payment of estimated taxes for the tax year 2011.

Baindurashvili v. Helpful Hands Transportation, Inc., No. A11-60, Unpub. (Minn. Ct. App. 11/21/2011) (A case recently won by Sherayzen Law Office)

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This is a copy of the Minnesota Court of Appeals unpublished opinion in the case recently won by Mr. Eugene Sherayzen, the owner of Sherayzen Law Office, on November 21, 2011.

 

This opinion will be unpublished and
may not be cited except as provided by
Minn. Stat. § 480A.08, subd. 3 (2010).

STATE OF MINNESOTA
IN COURT OF APPEALS
A11-60

Avtandil Baindurashvili,
Respondent,

Vyacheslav Kirkov,
Respondent,

vs.

Helpful Hands Transportation, Inc.,
Relator,

Department of Employment and Economic Development,
Respondent.

Filed November 21, 2011
Reversed and remanded
Kalitowski, Judge

Department of Employment and Economic Development
File Nos. 25886858-3, 26006922-4

Avtandil Baindurashvili, Crystal, Minnesota (pro se respondent)

Vyacheslav Kirkov, Burnsville, Minnesota (pro se respondent)

Eugene A. Sherayzen, Minneapolis, Minnesota (for relator)

Lee B. Nelson, Amy R. Lawler, Department of Employment and Economic Development, St. Paul, Minnesota (for respondent Department of Employment and Economic Development)

Considered and decided by Stoneburner, Presiding Judge; Kalitowski, Judge; and
Peterson, Judge.

U N P U B L I S H E D   O P I N I O N

KALITOWSKI, Judge

In this certiorari appeal, relator transportation company challenges the determination by an unemployment-law judge (ULJ) that respondents, drivers who transported patients for relator, were employees rather than independent contractors and accordingly were eligible for benefits under the unemployment-benefits laws.  Relator argues:  (1) the ULJ’s findings do not support a determination that respondents were employees; (2) the ULJ erred by failing to follow the structural framework set forth in Minn. R. 3315.0555 (2009); and (3) the ULJ’s decision was arbitrary and capricious.  Because the ULJ made findings that are inconsistent with a determination of employee status and failed to follow the analytic structure of Minn. R. 3315.0555, we reverse and remand.

D E C I S I O N

Respondents Avtandil Baindurashvili and Vyacheslav Kirkov worked as drivers for  relator Helpful Hands Transportation, Inc. (Helpful Hands) from 2003 and 2007, respectively, until June 2010.  Helpful Hands contracts with insurance companies to provide nonemergency medical transportation and hires drivers to transport patients. Prior to 2009, Helpful Hands classified drivers as employees.  In April 2009, Helpful Hands began to treat drivers as independent contractors.

Baindurashvili and Kirkov applied for unemployment benefits after their separations from Helpful Hands.  Respondent Department of Employment and Economic Development (DEED) conducted an audit and determined that the drivers were employees for purposes of unemployment-benefits law.  Helpful Hands appealed the determinations and the matters were consolidated for a telephone hearing before the ULJ. The ULJ determined that Baindurashvili and Kirkov were employees of Helpful Hands.

Employers must contribute to the unemployment trust fund based on wages paid to employees.  See Minn. Stat. § 268.035, subd. 25 (2010).  But payments to independent contractors do not constitute wages under Minnesota unemployment law.  Nicollet Hotel
Co. v. Christgau, 230 Minn. 67, 68, 40 N.W.2d 622, 622-23 (1950).

Whether an individual is an employee or an independent contractor is a mixed question of law and fact.  Nelson v. Levy, 796 N.W.2d 336, 339 (Minn. App. 2011).  This court reviews a ULJ’s factual findings in the light most favorable to the decision and will not disturb them if sustained by substantial evidence.   Skarhus v. Davanni’s Inc., 721 N.W.2d 340, 344 (Minn. App. 2006).   Questions of law are reviewed de novo.  Ywswf v. Teleplan Wireless Servs., Inc., 726 N.W.2d 525, 529 (Minn. App. 2007).

Five factors are used to determine whether a worker is an employee or an independent contractor:  “(1) The right to control the means and manner of performance; (2) the mode of payment; (3) the furnishing of material or tools; (4) the control of the premises where the work is done; and (5) the right of the employer to discharge.”  Guhlke v. Roberts Truck Lines, 268 Minn. 141, 143, 128 N.W.2d 324, 326 (1964) (codified at Minn. R. 3315.0555, subp. 1).  Of these five factors, the two most important are “the right or the lack of the right to control the means and manner of performance,” and the right or the lack of the right “to discharge the worker without incurring liability.”  Minn. R. 3315.0555, subp. 1.   Subpart 3 sets forth  criteria to be considered when evaluating whether the right to control the means and manner of performance exists.  Minn. R. 3315.0555, subp. 3.  Subpart 2  provides additional factors that may be considered if analysis of the five essential factors is inconclusive.  Minn. R. 3315.0555, subp. 2.

Helpful Hands argues that the ULJ’s findings of fact as to the issue of control are contradictory and  inconsistent with his  ultimate conclusion  that the drivers are employees.  We agree.  The ULJ found,

A  driver, usually the driver in the most convenient location who is available, is contacted the day the service is needed and asked if he is able and willing to accept the assignment. If the driver declines, another driver is contacted. . . . [Helpful Hands] does not dictate how a driver does his job or what  route is driven and it does not require drivers to work specific hours.

The ULJ concluded, “ultimately there is little if any control to be had over how the actual transport is conducted.”  These findings suggest that Helpful Hands did not retain the right to control the drivers’ means and manner of performance and tend to support
independent-contractor status.

The ULJ did make other findings of fact that weigh in favor of employee status. But if the ULJ determined that other factors in the  Minn. R. 3315.0555 analysis outweighed these findings on the issue of control, explanation was necessary.  Because the ULJ failed to set forth  such  analysis, we are unable to review  the decision to determine whether it is supported by substantial evidence.   See Minn. Stat. § 268.105, subd. 7(d) (2010) (providing that this court may reverse or modify the decision of a ULJ if a party has been prejudiced by findings, inferences, conclusions or decisions that are unsupported by substantial evidence in view of the entire record as submitted).

We do not suggest that all factual findings relating to the factors in Minn. R. 3315.0555 must support the final determination of worker status.  Indeed, the various factors may  tend to support either determination and may be inconsistent with one another.  See St. Croix Sensory, Inc. v. Dep’t of Emp’t & Econ. Dev., 785 N.W.2d 796, 800-04 (Minn. App. 2010) (finding that some factors indicated control and an employment relationship, while others indicated a lack of control and an independentcontractor relationship, and holding that on the totality of the circumstances the workers were independent contractors).   But there must be a logical link between the findings on the important factor of the right to control the means and manner of performance and the ultimate conclusion.

Helpful Hands next argues that the ULJ failed to follow the analytic framework set forth in Minn. R. 3315.0555.  We agree.  The ULJ determined that analysis of two of the essential factors—the right to control the means and manner of performance and the right to discharge without incurring liability—was inconclusive but did not make a finding as to whether analysis of all five essential factors was inconclusive before addressing the additional factors.  See Minn. R. 3315.0555, subp. 1 (providing that if the five essential factors of subpart 1 are inconclusive, the additional factors of subpart 2 should be considered).  The ULJ also considered certain subpart 3 criteria as stand-alone factors and thus did not properly weigh them in his analysis of control of the means and manner of performance.  See id. at subp. 3 (setting forth “criteria for determining if the employer has control over the method of performing or executing services”).

Finally, Helpful Hands contends that the ULJ’s decision is arbitrary and capricious because the ULJ relied on a factor—the importance of the worker to the company—that is not included in Minn. R. 3315.0555.  We disagree.  An agency ruling is arbitrary and capricious if the agency relied on factors not intended by the legislature.   Citizens Advocating Responsible Dev. v. Kandiyohi Cnty. Bd. of Comm’rs, 713 N.W.2d 817, 832 (Minn. 2006).  The ULJ’s discussion of the importance of the drivers to Helpful Hands’s business informed the ULJ’s analysis of whether the workers’ activity was performed in the course of the employer’s business.  Minn. R. 3315.0555, subp. 2H includes whether services are performed in the course of the employer’s business as an additional factor in the worker-status analysis, and provides,  “services  which  are a part or process of the employer’s trade or business are generally performed by individuals in employment. . . . Process refers to those services which directly carry out the fundamental purposes for which the organization, trade, or business exists . . . .”  The ULJ’s consideration of the importance of the drivers to the company did not depart from the rule and was  not arbitrary and capricious.

In conclusion, we reverse and remand for findings of fact and conclusions of law consistent with this opinion in such proceedings as the ULJ deems appropriate.

Reversed and remanded.

Eugene Sherayzen, Esq. Wins a Minnesota Court of Appeals Case

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On November 21, 2011, the Minnesota Court of Appeals ruled in favor of Helpful Hands Transportation, Inc. (HHT) – the client of Sherayzen Law Office – and reversed the unemployment law judge’s (ULJ) determination that HHT’s workers should be classified as employees. Judge Kalitowski wrote the opinion.  Two respondents were listed as “pro se”, but the opinion of the ULJ was defended by Minnesota Attorney General’s Office on behalf of the Department of Employment and Economic Security (DEED). Mr. Eugene Sherayzen represented our client throughout the case.

At the center of the issue was whether the ULJ erred in its determination that HHT’s workers were employees.  Mr. Sherayzen’s chief arguments were: (1) the ULJ’s factual findings are inconsistent with his legal conclusion, and (2) the ULJ failed to follow the analytical framework of Minnesota Rule 3315.0555.   The Court of Appeals agreed with both arguments and reversed the decision.

A copy of the court opinion will be posted on our website later.

Contact Sherayzen Law Office For Appellate Litigation

If you have a case that you wish to appeal to the Minnesota Office of Administrative Appeals, Minnesota Court of Appeals or Minnesota Supreme Court, contact Sherayzen Law Office.  Our experienced appellate tax firm will assist you in filing the case, constructing efficacious legal arguments, drafting compelling legal briefs,  and zealously representing your interests in applicable courts.