This is a case which I know very well by heart because this case took four years to complete. It involved a very large number of companies and I’m very proud of that case because there were only two possibilities there. Either my client will pay millions in penalties or he will pay zero; he paid zero, so I’m very proud of that.
One part of that case was a situation (and this all takes place in Eastern Europe), in that particular country the law was passed which allowed the companies to change one business form into another. So what I mean is that a Corporation can become a Partnership; a Partnership can become a Corporation. For US Tax Purposes there are really only three:
A Disregarded Entity
A company could not become a Disregarded Entity under the Local Law. In this situation the Corporation was a real estate company with some strange outside transactions which have nothing to do with what we are going to be discussing.
This company owned a lot of real estate and they decided to take advantage of that Local Law and they switched the company from the Corporation into the Partnership. Under the law, you didn’t have to do anything to the financial statements so the financial statements continued to be filed in exactly the same form as they were filed before.
So basically, let’s say that the switch occurred sometime in February of 2010; the Corporation would file the Foreign Tax Returns through the end of January and then the Partnership would begin where the Corporation left off from February to the end of the year.
To advise about that switch there were four total advisors; one was a US Accountant in New York but he didn’t input much really. Let’s put it this way, he was brought in but didn’t advise on anything. The most important advisors were the local International Tax Advisors; (there were three of them). One was a guy who actually knows a lot; I know him because I worked with him for years so this guy actually is a professional; but he’s not a US Tax Professional. He’s a very very bright guy so when I had an issue and I wanted to explore how things should be done in this country, I would go to him. He really knows his stuff.
In this case, he didn’t know his stuff completely because he wasn’t a US International Tax Attorney; so what he did is he said to the client: ‘From our perspective, as we see, the Local Law will dominate and therefore US Tax Law has no input here whatsoever. Why does the US – the Law Care? What does it have to do with which is basically switching one company to the other? Nothing is being recognized; no income tax consequences. What’s the problem? No problem.’ So the other two advisors agreed.
The transaction took place and then some years later I received this case and we’re talking about a Voluntary Disclosure content so I have to go back eight years. So when I go back eight years, I see that there’s this inexplicable change in the name first of all because the name was changed at the end because one was a Corporation and the other one was a Partnership. The second one is that I saw these interesting financials. Here’s one financial for January and then the another set of financials from February to December and I asked my client what was going on there.
Gradually after some back and forth and discussing this case with a local international tax advisor, I realized what happened.
Do you want to know for US Tax Purposes what this was? A Dissolution of the Corporation and a Formation of the Partnership. That means there were Tax Consequences, and huge Tax Consequences. Because it was also a Controlled Foreign Corporation, there was a Subpart F income recognition. Now, we worked hard, we worked hard where we could minimize the tax liability etc. etc. (I forgot to mention the most important thing here however, there was a Business Lawyer involved.) A US Business Lawyer was involved in this transaction because the US Business Lawyer was also a real estate expert. So he came in; the reason why they were making this change more for real estate purposes to make it easier to dispose of real estate; that was really the reason.
So, he was there but he said: ‘I don’t know; these are your Local International Tax Advisors, not really a problem.’
This is a great illustration of the Foreign Exceptionalism Trap and how it is a very dangerous thing and this is just one example. I can give you dozens of examples on this issue where I personally was involved in cases where this was a repeated problem, one case after another and it continues on despite the fact that there is FATCA in place.
How many people here have heard of FATCA the Foreign Account Tax Compliance Act? Despite the fact that there are huge changes in the European Union in terms of the Tax Information Exchange and the growing awareness of this problem of US really Exceptionalism more than anything else.
Despite all that, this problem is ever-present. Because a lot of you are involved in International Business Transactions; I want to make sure that I convey that to you.