Financing Improper Payments with a Company's Foreign Subs

Financing Improper Payments with a Company's Foreign Subs


 You can download a full copy of the slides from this webinar. 




Full video transcript available below:

Hello, everyone, and welcome to today's webinar, hosted by me, Joe Boyhan, of MCO, and international tax expert, Selva Ozelli. Today's webinar is titled Is This Bribe Tax Deductible? I'm now gonna pass you on to Selva, who's gonna start today's webinar.


Now, we focus on page 27 of your presentation, on the topic of financing improper payments through [inaudible 00:29:33]. As in the case of Odebrecht, which had a whole department, actually, to making bribery payments, a company usually makes bribery payments to foreign officials to obtain an economic benefit that will boost this company's earnings and profit, which in turn will enhance top management bonuses and incentive pay. For these purposes, a company typically uses a slush fund, or in some companies, it's a whole department to finance improper payments.


A slush fund can exist at the parent company, or it can be created in a foreign subsidiary, when funds are secretly transferred from the parent company to the foreign subsidiary, in form of capital contributions, cross border asset transfers, artificial tax reduction motivated into company financing, or it could be a corporate restructuring transaction, where a form of ownership of assets from parent to foreign subsidiary may change, but a significant continuity of the economic substance of the ownership of the slush funds remains, so that is important to tax investigators.


These slush funds, they typically are hidden in foreign bank accounts or foreign subsidiaries, and they may not be reported to tax authorities. Neither the income of the company that finances these payments, and this can cast a doubt on the integrity and reliability of the corporate books and records. It can also point to tax evasion. For these purposes, the IRS could use the transfer pricing rules to redress the intercompany slush fund financing, and disallow any tax deductions claimed by the parent company, under section 162 C1.


The corruption investigation may originate with the finding of a corporate slush fund. Once it's found, this investigation could then spread to companies, subcontractors, joint venture partners, and various politicians. Let's now go to page eight of the presentation, and look at an investigation that's ongoing in Korea. On July 17th of this year, prosecutors widened their investigation into Korea Aerospace Industries, and Korea aerospace industry's president and CEO, Ha Sung-yong, over his alleged use of a corporate slush fund to lobby Korean government officials to extend his presidency at the company, and also, to get funding for various Korean Aerospace Industries programs.


The CEO is suspected of unfair business practices by embezzling trillions from the Korean government by signing unfair contracts with the subcontractors and inflating production costs to develop aerospace defense aircraft, sometimes that were developed with the technical assistance of other aerospace companies, particularly the US aerospace giant, Lockheed Martin, so one thing to keep in mind is that a company can be jammed into a corruption and tax evasion investigation because of the illicit conduct of one of its joint venture partners, subcontractors, or because it was complicit in aiding and abetting tax evasion and corruption.


In addition, banks and lawyers can also be dragged into these corruption investigations, and tax evasion investigations. I want to bring to your attention that banks have been shutting down around the world for aiding and abetting in tax evasion. For example, in 2013, the Department of Justice shut down the oldest Swiss bank, it was a private bank, [inaudible 00:35:08] after it admitted in aiding US tax evasion. In 2014, two branches of First Bank [inaudible 00:35:16] were shut down by officials of Niger state board of internal revenue for tax evasion. In 2016, German authorities shut down Canada's Maple Bank for tax evasion and money laundering. The same year, Singapore's central bank shut down two Swiss private bank Singapore branches, [inaudible 00:35:41] because of aiding in tax evasion and money laundering.


Now, new tax and treasury reporting requirements have been adopted across the world in 2016. The US version of this is called FATCA, which you are maybe aware of, and other than FATCA, there's also the CRS, which was adopted worldwide, and these legislations impose extensive reporting obligations on offshore accounts. In addition to that, there's a new reporting requirement that will become effective in 2018, proposed by the US treasury department since then. It's the customer due diligence rule. This rule will require covered financial institutions, including banks, brokers, mutual funds, to obtain information concerning the beneficial owners of accounts held by entities. Under the customer due diligence rules, financial institutions are required to identify natural persons who own 25% or more of an entity that owns a US financial account, or who has a significant responsibility to control such entity.


These standards will become valid in 2018, and banks and financial institutions will have to comply with them. In addition to that, a similar anti money laundering law that will become effective in 2018, in the EU, is the central registry for beneficial ownership information. As of beginning of 2018, interconnected registries will be created in each member state of the EU, to record details of beneficial ownership of companies and trusts, and this is going to be required by EU's fourth anti money laundering directive. The central registries of beneficial owners will be made available to local tax authorities, and will be shared between tax authorities within the EU. Two countries have already implemented central registries, UK as of June 1st, 2016, and Ireland, as of November 15th, 2016, which you should become aware of.


We mentioned that improper payments can be made by a US company's foreign subs. There are certain tax rules that apply to different kinds of foreign subs that will make a tax deduction for bribery illegal, and I would like to highlight those. 100% owned foreign subsidiary may not make a tax deduction for bribes. Also, more than 50% owned, control foreign corporation, the deduction will be disallowed. In case of less than 50% owned foreign subsidiaries, if the company is engaged in a trade or business within the United States, then the bribery deduction will be disallowed, and also, there's a specific type of foreign subsidiary or foreign company taxed under US tax rules, which is called the Passive Foreign Investment Company. Again, for those entities, that could be an investment vehicle. Payments for bribery deductions will not be tax deductible.


There is a new tax reporting rule that is applicable to US companies, starting in 2017. It's been adopted by other countries starting 2016, which is called the Country by Country Report. Country by Country Report was based on OECD's action plan 13. It attempts to standardize annual tax reporting for companies by providing a high level global picture of the company's profits, tax and economic activities on a country by country basis. For US purposes, this report will be reported, filed for the first time, and it will be automatically exchanged with tax treaty and tax information exchange agreement country. The specifics are outlined in your presentation. I am not gonna go into a whole lot of detail, because we are running out of time, but just know that the types of entities that are required to make a disclosure are defined under tax rules, and it pretty much covers every entity, so I think tax departments, and compliance professionals should talk to one another and get a sense of how much disclosure is going to be required under the Country by Country Report this year, because that's going to provide a lot more transparency about a country's activities abroad.


Another reporting requirement that applies to US company's foreign subs is under the US Bureau of Economic Analysis. Since 2015, the Bureau of Economic Analysis instituted mandatory reporting requirements for public and also private US companies, regarding direct investment in foreign companies. Noncompliance with these reporting rules subjects the tax payer to civil as well as criminal penalties.


Find out how MCO can help

Request a demo today to learn how MyComplianceOffice puts you in command of your compliance program, synchronizing your business needs with regulation. 

Request a Demo



Download our four page Portfolio of Solutions to learn about;

  • Personal Trade Monitoring
  • Gifts & Entertainment
  • Political Contributions
  • Third Party vendor risk management
  • Trade surveillance
  • And more

Brochure Download