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International TaxControversies

A Practical Guide

2018 Edition

Philip R. WestJ. Walker Johnson

Amanda VarmaMichael Durst

Steptoe & Johnson LLP

Practising Law InstituteNew York City

#206153

This work is designed to provide practical and usefulinformation on the subject matter covered. However, it issold with the understanding that neither the publishernor the author is engaged in rendering legal, accounting,or other professional services. If legal advice or otherexpert assistance is required, the services of a competentprofessional should be sought.

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Copyright © 2017 by Practising Law Institute. All rights reserved.

Printed in the United States of America. No part of this publication may bereproduced, stored in a retrieval system, or transmitted in any form by anymeans, electronic, mechanical, photocopying, recording, or otherwise,without the prior written consent of Practising Law Institute.

LCCN: 2014944097

ISBN: 978-1-4024-2975-0

About the Authors

PHILIP R. WEST is the chairman of Steptoe & Johnson LLP. He is oneof the premier international tax lawyers in the country and isconsistently ranked among the best tax practitioners in publicationssuch as Chambers USA, Chambers Global, and the Legal 500.Focused mainly on international tax issues for both domestic andforeign clients, Mr. West helps clients favorably resolve controversieswith, and obtain rulings and other favorable guidance from, the IRS,Treasury, and the Department of Justice. Mr. West also has extensivepractical experience advising on international business operations andtransactions, with deep substantive knowledge of income deferral,foreign tax credits, transfer pricing, tax treaties, tax withholding andreporting, and the tax aspects of cross-border mergers, acquisitions,joint ventures, investment funds, and financings. Mr. West served fornearly four years as the Treasury Department’s International TaxCounsel, the senior international tax lawyer in the U.S. government.In that position, he played a central role in virtually every policy,legislative, and regulatory development in the international tax areaand led tax treaty negotiations, discussions, and ratification effortsinvolving countries throughout the world. Earlier in his career,Mr. West litigated tax cases with the Justice Department, advisedJudge Carolyn Miller Parr as a Tax Court clerk, and practiced bothwith a Wall Street law firm and in the national office of aninternational accounting firm.

J. WALKER JOHNSON is a partner in the Washington, D.C. office ofSteptoe & Johnson LLP. At Steptoe, Mr. Johnson’s practice focuses ontax controversies and tax litigation. He has litigated numerous casesin district court, the Tax Court and the Court of Federal Claims, aswell as in various Circuit Courts of Appeals and the U.S. SupremeCourt. Prior to joining Steptoe, he was a Trial Attorney at theDepartment of Justice’s Tax Division, where he was awarded the TaxDivision’s Outstanding Attorney Award. Mr. Johnson’s practice hasinvolved not only transfer pricing, but also the taxation of insurancecompanies and other financial institutions. Since 1987, he has servedas an Adjunct Professor of Law in the Graduate Tax Program at

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the Georgetown University Law Center, teaching a course titledTaxation of Financial Institutions and Products. He is consistentlyrecommended for tax controversy in Chambers USA, Legal 500 US,and Lawyers in America.

AMANDA VARMA is a partner in the Washington, D.C. office of Steptoe& Johnson LLP. Her practice focuses on international tax controver-sies, including audits, Appeals, competent authority proceedings, andlitigation, as well as international tax planning. She advises clients ona broad range of international tax matters, including tax treatymatters; withholding and reporting; transfer pricing; cross-borderacquisitions, restructurings, and financings; anti-deferral rules;foreign tax credits; and business and individual voluntary disclosures.She has been recommended in Legal 500 US, Tax: International Tax,and Tax: Tax Controversy.

MICHAEL DURST is special counsel in the Washington, D.C. office ofSteptoe & Johnson LLP. He has been a member of the District ofColumbia Bar for more than thirty years. He has practiced, taught,and written extensively over the years, primarily in the fields oftransfer pricing, international taxation, and taxation in developingcountries. He is a former Director of the IRS Advance PricingAgreement Program. He holds a Master ’s Degree in Economics fromM.I.T., a J.D. from the University of California, Berkeley, and an LL.M.from Harvard Law School.

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INTERNATIONAL TAX CONTROVERSIES

Table of Chapters

PART I: International Tax Audits and Appeals

Chapter 1 Early Preparation and Documentation for Audit andControversy

Chapter 2 Pre-Audit Planning, Including Document Retention andSpoliation

Chapter 3 Handling the International Examination

Chapter 4 Special Document Issues in International Examinations

Chapter 5 IRS Appeals and Special Appeals Procedures

PART II: Government-to-Government Cooperation

Chapter 6 The Role of the Competent Authority: Mutual AgreementProcedures

Chapter 7 Advance Pricing Agreements

Chapter 8 Exchange of Information

PART III: Litigating International Tax Cases

Chapter 9 Post-Appeals Litigation Options and Choice of Forum

Chapter 10 Discovery in International Tax Cases

Chapter 11 Trial and Appellate Practice

ix

Table of Contents

About the Authors .......................................................................... vii

Table of Chapters ............................................................................ ix

Preface and Acknowlegments ......................................................xxi

PART I: International Tax Audits and Appeals

Chapter 1 Early Preparation and Documentation forAudit and Controversy

§ 1:1 Introduction .................................................................... 1-1§ 1:2 Sensitizing the Business .................................................. 1-2§ 1:3 Documenting the Business Purpose Narrative ................ 1-4§ 1:4 Developing Documentation Supporting the Tax

Treatment of the Transaction .......................................... 1-6§ 1:5 Avoiding the Creation of Contradictory Documents ...... 1-9§ 1:6 Transactions Likely to Be Scrutinized ............................. 1-9§ 1:7 Case Studies .................................................................. 1-11

§ 1:7.1 International Hybrid Instrument Transactions ...... 1-11§ 1:7.2 Transfer Pricing Issues............................................ 1-14

§ 1:8 Conclusion .................................................................... 1-17

Chapter 2 Pre-Audit Planning, Including DocumentRetention and Spoliation

§ 2:1 Introduction .................................................................... 2-2§ 2:2 The Duty to Retain Documents...................................... 2-2§ 2:3 Establishing an Effective Document Retention Policy..... 2-5

§ 2:3.1 What Documents Should Be Retained ..................... 2-6§ 2:3.2 Document Retention Periods.................................... 2-9§ 2:3.3 Special Consideration for Email and Other

Electronically Stored Information........................... 2-10§ 2:3.4 Document Retention Policy Training ..................... 2-10§ 2:3.5 Accidental Document Destruction ......................... 2-11

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§ 2:4 Protecting Privileges Applicable to RetainedDocuments .................................................................... 2-12

§ 2:4.1 Attorney-Client Privilege ........................................ 2-13§ 2:4.2 Work Product Doctrine........................................... 2-19§ 2:4.3 Section 7525: Communications with Federally

Authorized Tax Practitioners .................................. 2-24§ 2:4.4 Privilege in the International Context.................... 2-25

[A] Whose Privilege Law Applies? ................................ 2-25[B] Can U.S. Privilege Be Waived by Disclosure

to Another Jurisdiction? ......................................... 2-28§ 2:5 Spoliation ...................................................................... 2-29

§ 2:5.1 Interplay with Work Product Doctrine ................... 2-33§ 2:5.2 Litigation Holds...................................................... 2-35

§ 2:6 Conclusion .................................................................... 2-39

Chapter 3 Handling the International Examination

§ 3:1 Introduction .................................................................... 3-2§ 3:2 The IRS’s Selection of Returns to Be Examined.............. 3-2§ 3:3 The IRS’s Authority to Examine Returns........................ 3-2§ 3:4 Time Limits on the Examination.................................... 3-4§ 3:5 The Composition of the IRS Examination Team............ 3-5§ 3:6 The Type of Examination to Be Conducted .................... 3-8§ 3:7 Setting the Ground Rules for the Examination............. 3-11§ 3:8 Information Document Requests .................................. 3-12§ 3:9 Interviews and Facility Visits ........................................ 3-18§ 3:10 Formal Document Requests .......................................... 3-19§ 3:11 The Summons Process .................................................. 3-19

§ 3:11.1 Issuance of Administrative Summonsto the Taxpayer ....................................................... 3-19

§ 3:11.2 Issuance of a Designated Summonsto the Taxpayer ....................................................... 3-22

§ 3:11.3 Judicial Enforcement of Summons Issuedto the Taxpayer ....................................................... 3-24

§ 3:12 Requests for Information from Third Parties ................ 3-36§ 3:13 Issuance of Summons to Third Parties ......................... 3-38§ 3:14 Judicial Enforcement of a Third-Party Summons.......... 3-40§ 3:15 IRS Development of Issues and Proposed

Adjustments .................................................................. 3-43§ 3:16 Special Examination Processes and Procedures ............. 3-43

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§ 3:17 Mutual Agreement Procedure and CompetentAuthority ....................................................................... 3-46

§ 3:18 Resolution of Issues During the Examination............... 3-47

Chapter 4 Special Document Issues in InternationalExaminations

§ 4:1 Introduction .................................................................... 4-1§ 4:2 Information Made Available to the IRS .......................... 4-2§ 4:3 Information Document Requests .................................... 4-3§ 4:4 Examination of Documentation or Facilities

at Foreign Sites ................................................................ 4-4§ 4:5 Formal Document Requests for Foreign-Based

Documentation ............................................................... 4-4§ 4:6 Administrative Summons.............................................. 4-16§ 4:7 Judicial Enforcement of Summonses............................. 4-17§ 4:8 Judicial Review of Section 6038A Summons ................ 4-28§ 4:9 Privilege Defenses to Production ................................... 4-29

Chapter 5 IRS Appeals and Special Appeals Procedures

§ 5:1 Introduction .................................................................... 5-1§ 5:2 Resolution of Issues in Fast Track and Early Referral ..... 5-2

§ 5:2.1 Fast Track Settlement ............................................... 5-2§ 5:2.2 Early Referral ............................................................ 5-3

§ 5:3 Issuance of a Revenue Agent’s Report ............................. 5-5§ 5:4 Potential Responses to the Revenue Agent’s Report........ 5-6§ 5:5 Deciding Whether to File a Protest ................................. 5-7§ 5:6 Preparation of the Protest................................................ 5-9§ 5:7 Exams’ Rebuttal to the Protest and the Ex Parte

Conference .................................................................... 5-10§ 5:8 Extensions of the Assessment Period ............................ 5-11§ 5:9 Conduct of the Appeals Conference .............................. 5-11§ 5:10 Appeals Settlement Authority ....................................... 5-12§ 5:11 Appeals Settlement Considerations and Procedures...... 5-13§ 5:12 Appeals Alternative Dispute Resolution Programs........ 5-16§ 5:13 Appeals and Competent Authority Cases ..................... 5-16§ 5:14 Concluding the Appeals Process.................................... 5-18§ 5:15 Taking Unagreed Issues into Litigation......................... 5-19

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Table of Contents

PART II: Government-to-Government Cooperation

Chapter 6 The Role of the Competent Authority:Mutual Agreement Procedures

§ 6:1 Introduction .................................................................... 6-1§ 6:2 Legal Basis and Organization of U.S. Competent

Authority Office............................................................... 6-5§ 6:3 Overview of the Competent Authority Process ............... 6-6§ 6:4 The Taxpayer ’s Interest and Involvement in

Competent Authority Negotiations ................................. 6-8§ 6:5 Common Kinds of Double Taxation Issues..................... 6-9

§ 6:5.1 Transfer Pricing Issues.............................................. 6-9§ 6:5.2 Permanent Establishment Issues............................ 6-10§ 6:5.3 Residency Issues ..................................................... 6-11§ 6:5.4 Limitation on Benefits Issues ................................. 6-12§ 6:5.5 Withholding Tax Issues .......................................... 6-16§ 6:5.6 Thin Capitalization/Debt Equity Issues ................. 6-17§ 6:5.7 Pension Plan Qualification ..................................... 6-18

§ 6:6 Do Taxpayers Have a “Right” to CompetentAuthority Consideration? .............................................. 6-18

§ 6:7 Exhaustion of Foreign Administrative Remedies:Seeking Competent Authority Relief Can Be aRequirement for Claiming Foreign Tax Credits............. 6-22

§ 6:8 Procedures for Requesting Competent AuthorityAssistance...................................................................... 6-23

§ 6:8.1 Importance of Reference to Revenue Procedureand Procedural Rules of Applicable Treaty.............. 6-23

§ 6:8.2 Deadlines for Seeking Competent AuthorityAssistance............................................................... 6-23

§ 6:8.3 Need for Taxpayer to Keep U.S. and ForeignStatutes of Limitations Open Pending CompetentAuthority Negotiations ........................................... 6-29

§ 6:8.4 Drafting and Filing the Competent AuthorityRequest ................................................................... 6-30

§ 6:8.5 User Fees ................................................................ 6-31§ 6:8.6 Pre-Filing Conferences............................................ 6-32

§ 6:9 Coordination of Competent Authority Negotiationswith Other Administrative and Judicial Proceedings..... 6-34

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§ 6:9.1 Suspension of U.S. Administrative Action ............. 6-34§ 6:9.2 Coordination of Competent Authority and

IRS Administrative Proceedings ............................. 6-36§ 6:9.3 Competent Authority and Litigation ...................... 6-37

§ 6:10 Practical Observations on the Competent AuthorityNegotiation Process ....................................................... 6-38

§ 6:10.1 Taxpayer ’s Role in Negotiation............................... 6-38§ 6:10.2 “Tacking On” Additional Years to Ongoing

Competent Authority Negotiation.......................... 6-39§ 6:10.3 Closing Agreements and Correlative

Adjustments ........................................................... 6-40§ 6:10.4 Small Case Procedure ............................................. 6-42

§ 6:11 Effectiveness of the Competent Authority Process ........ 6-42§ 6:12 Tax Treaty Arbitration ................................................... 6-43

Chapter 7 Advance Pricing Agreements

§ 7:1 Introduction .................................................................... 7-1§ 7:2 APA Program Organization Within IRS .......................... 7-4§ 7:3 The Process of Obtaining an APA................................... 7-5

§ 7:3.1 When to Seek an APA .............................................. 7-5§ 7:3.2 Timing of APA Requests........................................... 7-8§ 7:3.3 Filing a Request ........................................................ 7-8§ 7:3.4 Fees........................................................................... 7-9§ 7:3.5 Pre-Filing Conference ............................................. 7-10§ 7:3.6 The APA Negotiation Process................................. 7-12§ 7:3.7 Critical Assumptions.............................................. 7-15§ 7:3.8 IRS Internal Review of APAs .................................. 7-15§ 7:3.9 IRS Checks on Compliance with APAs.................. 7-16

§ 7:4 Cancellation and Revocation of APAs ........................... 7-17§ 7:5 APA Renewals................................................................ 7-18§ 7:6 APAs Involving Branches............................................... 7-19§ 7:7 Financial Products APAs ............................................... 7-20§ 7:8 Customs Considerations and APAs .............................. 7-22

§ 7:8.1 Transfer Pricing Methodologies Used in APAs ....... 7-23§ 7:8.2 APAs and State and Local Taxation........................ 7-24§ 7:8.3 APAs in the Context of Tax Policy; Future

of APAs................................................................... 7-25§ 7:8.4 Public Disclosure of APAs ...................................... 7-26

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Table of Contents

Chapter 8 Exchange of Information

§ 8:1 Introduction .................................................................... 8-2§ 8:2 Tax Treaty Information Exchange.................................... 8-5

§ 8:2.1 Standard for Information Exchange.......................... 8-6[A] Overview................................................................... 8-6[B] Requests Lacking a Taxpayer Name.......................... 8-9

§ 8:2.2 Limitations on Obligation to Provide Information....8-14§ 8:2.3 Restrictions on Use of Information by

Contracting State.................................................... 8-15§ 8:2.4 Other Common Provisions .................................... 8-16

[A] Domestic Tax Interest ............................................ 8-16[B] Form of Information Provided ................................ 8-17[C] Mode of Application ............................................... 8-17

§ 8:3 Tax Information Exchange Agreements......................... 8-18§ 8:4 Mutual Legal Assistance Treaties .................................. 8-19§ 8:5 Confidentiality of Information Exchanged .................... 8-20§ 8:6 Types of Information Exchange ..................................... 8-23

§ 8:6.1 Overview................................................................. 8-23§ 8:6.2 Specific Requests..................................................... 8-23

[A] Overview................................................................. 8-23[B] Foreign-Initiated Requests ...................................... 8-24[B][1] Process................................................................ 8-24[B][2] Summons to Obtain Information to Be

Exchanged .......................................................... 8-26[B][3] Considerations for Taxpayers Who Are the

Subject of a Foreign-Initiated InformationExchange Request............................................... 8-29

[C] U.S.-Initiated Requests ........................................... 8-30[C][1] Process................................................................ 8-30[C][2] Considerations for Taxpayers Who Are the

Subject of a U.S.-Initiated InformationExchange Request............................................... 8-32

[C][3] IRS Use of Summons in Lieu ofInformation Exchange ........................................ 8-32

§ 8:6.3 Routine/Automatic Exchange.................................. 8-34[A] In General .............................................................. 8-34[B] FATCA and Other Developments in Automatic

Information Exchange ............................................ 8-35§ 8:6.4 Spontaneous Exchange ........................................... 8-36§ 8:6.5 Industry-Wide Exchanges of Information ............... 8-37

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§ 8:6.6 Simultaneous Examination, SimultaneousCriminal Investigation Programs, and JointAudits ..................................................................... 8-37

§ 8:7 Joint International Tax Shelter Information Centre...... 8-38§ 8:8 Collection Assistance .................................................... 8-39

§ 8:8.1 Overview................................................................. 8-39§ 8:8.2 The Revenue Rule................................................... 8-40§ 8:8.3 U.S. Tax Treaty Modification of the Revenue

Rule ........................................................................ 8-42[A] In General .............................................................. 8-42[B] Collection Assistance Treaty Provisions ................. 8-42[B][1] Broad Assistance Provision ................................ 8-43[B][2] Restrictive Collection Assistance Provision........ 8-43[B][3] The OECD Convention on Mutual

Assistance in Tax Matters .................................. 8-45

PART III: Litigating International Tax Cases

Chapter 9 Post-Appeals Litigation Options andChoice of Forum

§ 9:1 Introduction .................................................................... 9-1§ 9:2 Exiting Appeals While Positioning a Case for

Litigation ......................................................................... 9-2§ 9:2.1 Positioning a Case for Tax Court Litigation ............. 9-2§ 9:2.2 Positioning a Case for Refund Litigation.................. 9-3

§ 9:3 The Process of Initiating the Litigation........................... 9-4§ 9:3.1 Steps to Initiate Tax Court Litigation....................... 9-4§ 9:3.2 Steps to Initiate Refund Litigation ........................... 9-5

§ 9:4 Choice of Forum Considerations .................................... 9-8§ 9:4.1 Need to Pay the Asserted Tax Deficiency ................. 9-8§ 9:4.2 Applicable Precedent................................................. 9-8§ 9:4.3 The Government’s Ability to Raise New

Issues in Litigation ................................................... 9-9§ 9:4.4 The Taxpayer ’s Ability to Raise New Issues in

Litigation ................................................................ 9-11§ 9:4.5 Allowable Discovery ............................................... 9-14§ 9:4.6 The Tax Expertise and Experience of the Judge...... 9-15§ 9:4.7 The Attorneys Representing the Government ........ 9-16§ 9:4.8 The Location of the Trial........................................ 9-17§ 9:4.9 The Possibility of a Jury Trial................................. 9-17

§ 9:5 Supreme Court Review.................................................. 9-18

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Table of Contents

Chapter 10 Discovery in International Tax Cases

§ 10:1 Introduction .................................................................. 10-1§ 10:2 Overview of Discovery Methods.................................... 10-2§ 10:3 Discovery in U.S. District Courts ................................. 10-3§ 10:4 Discovery in the Court of Federal Claims................... 10-10§ 10:5 Discovery in the U.S. Tax Court ................................. 10-11§ 10:6 Hague Evidence Convention ....................................... 10-15

§ 10:6.1 Letters of Request ................................................. 10-15§ 10:6.2 Deposition Testimony Taken Through

Diplomatic or Consular Officers andAppointed Commissioners ................................... 10-19

§ 10:7 Letters Rogatory........................................................... 10-21§ 10:8 Coordination Between the Hague Evidence

Convention and Discovery Rules ................................ 10-23§ 10:9 Practical Considerations for Using Letters of

Request and Letters Rogatory ...................................... 10-28§ 10:10 Practical Considerations for Using Letters of Request

and Federal Rules of Civil Procedure Discovery .......... 10-29§ 10:11 Discovery in the United States for Use in Foreign

Proceeding ................................................................... 10-31

Chapter 11 Trial and Appellate Practice

§ 11:1 Introduction .................................................................. 11-1§ 11:2 Trial Practice.................................................................. 11-2

§ 11:2.1 Drafting the Complaint or Petition........................ 11-2§ 11:2.2 Local Rules and Judge-Specific Rules ...................... 11-3§ 11:2.3 Foreign Witnesses ................................................... 11-3§ 11:2.4 Foreign Documents ................................................ 11-6§ 11:2.5 Foreign Law .......................................................... 11-10§ 11:2.6 Foreign Experts ..................................................... 11-11§ 11:2.7 Burden of Proof..................................................... 11-12§ 11:2.8 The “Electronic Courtroom” ................................ 11-14§ 11:2.9 Use of Demonstratives ......................................... 11-15§ 11:2.10 Settlement ............................................................ 11-16§ 11:2.11 Coordination with Competent Authority

Proceedings ........................................................... 11-17§ 11:3 Appellate Practice ........................................................ 11-18

§ 11:3.1 The Decision to Appeal........................................ 11-18§ 11:3.2 Appellate Venue.................................................... 11-20

xviii


§ 11:3.3 Notice of Appeal ................................................... 11-20§ 11:3.4 Appeal Bond ......................................................... 11-21§ 11:3.5 Appellate Procedures............................................. 11-22§ 11:3.6 Final Decision or Judgment.................................. 11-23

Index ................................................................................................I-1

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Table of Contents

Preface and Acknowledgments

This book is a practical guide to resolving U.S. international taxcontroversies. Disputes with the Internal Revenue Service (IRS)regarding international tax issues often present special issues inaddition to those normally relevant in purely domestic tax con-troversies. For example, questions may arise regarding the applicationof attorney-client privilege and other protections in the cross-bordercontext. Where relevant documents, witnesses, and other informationare held abroad, special procedures may be applicable. In addition,special dispute resolution mechanisms may be available in interna-tional tax disputes involving tax treaties and transfer pricing. Thisbook explores these and other relevant considerations in internationaltax cases, in addition to the issues and procedures that commonlyarise in U.S. federal tax audits (whether or not focused oninternational issues).

Chapters 1 through 5 discuss international tax audits and IRSAppeals. Chapter 1 discusses early preparation for potential taxcontroversies, including best practices to adopt to help insure thattransactions are well-supported if subsequently challenged. Chapter 2discusses both legal and practical obligations to retain documents andconsiders the relevant rules and doctrines that may protect certaindocuments from disclosure. Chapter 3 discusses how taxpayers maybest handle international examinations and explains the ability of theIRS to examine tax returns, the procedures that the IRS typicallyutilizes in its examinations, and the options available to taxpayers toinfluence the examination process. Chapter 4 addresses special issuesthat arise in international examinations, including procedures thatare applicable when the IRS seeks documents, testimony, and otherinformation located in foreign locations and/or held by foreignentities. Chapter 5 focuses on how a case can be closed out of theexamination process and, where desired, moved into the IRS Appealsprocess.

Chapters 6 through 8 discuss government-to-government coopera-tion and special dispute resolution mechanisms in international taxcontroversies. Chapter 6 explains the mutual agreement procedure

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(MAP) processes available under tax treaties and practical consid-erations in MAP cases, while chapter 7 focuses on advance pricingagreements (APAs) that may be entered into by taxpayers and govern-ments to resolve and prevent transfer pricing disputes. Chapter 8describes information exchange under tax treaties and other agree-ments between countries and the potential impact of informationexchange on U.S. tax controversies.

Chapters 9 through 11 focus on litigating international tax cases.Chapter 9 analyzes post-Appeals litigation options, including con-siderations relevant to choosing the most favorable tax litigatingforum. Chapter 10 analyzes discovery mechanisms, with particularfocus on the ability to obtain testimony, documents, and otherevidence from foreign natural persons and entities located abroad.Chapter 11 discusses trial and appellate practice in international taxcases, including special issues that can arise in the litigation of com-plex tax cases involving foreign documents and witnesses.

The authors gratefully acknowledge the assistance of Felicia Carter,Brigid Kelly, Matthew Lerner, and Dianna Mullis in researching anddrafting parts of this book. In addition, they thank Harriet Farrow, JillTaylor Pope, and Timaka Senior for their assistance in formatting andcite-checking. All errors and omissions remain the authors’.


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