Please Complete The Following Case Study In Lieu Of The Prob

Please Complete The Following Case Study In Lieu of the Problem Sett

Please complete the following case study, in lieu of the problem set. The below scenario is based on the real life tax situation of one of my clients, with fictitious names and figures (for privacy). Please apply your knowledge from readings and research to this case. Mike and Rita are two partners in a retail distribution management business. They each contributed 50% of seed capital to start the partnership, M&R company. The entity was set up in Oklahoma in 2008, and has been profitable since its inception. In 2009, Mike moved his family to Costa Rica, while Rita moved to California. For the entire years of 2010 through 2012, Mike resided in Costa Rica, enjoying the international living. He traveled every month to the US on business, either for trade shows or client meetings. Mike has decided to stay in Costa Rica for a long term. He also has a daughter at 12, from his previous marriage, who lives in Oklahoma with her mother. The business is doing well despite the global recession and uncertainty. It is projected that the net earnings of the business will be in $300,000 in 2012. For the past two years, Mike devoted the majority of time to the business among the partners. The split between Mike and Rita is roughly 75% / 25%. This contribution will likely continue as most of the operation is located in Costa Rica. Mike is now contemplating setting up another legal entity in Costa Rica, which likely will be a stand-alone entity from the existing entity, M&R. What are the some tax considerations in Mike’s case? What are advantages and disadvantages of the new entity in Costa Rica?

Paper For Above instruction

The scenario presented involves complex international tax considerations arising from the establishment of a new business entity in Costa Rica by a U.S.-based partnership member. To analyze these considerations thoroughly, it is essential to evaluate the tax implications for Mike, the current partnership structure, and the potential benefits and drawbacks of creating a new Costa Rican entity.

Firstly, in terms of U.S. tax considerations, Mike’s residency in Costa Rica and his substantial involvement in the business pose questions about his tax status, reporting obligations, and how income derived from the business will be taxed. The United States taxes its citizens and resident aliens on worldwide income, regardless of where they reside, meaning that Mike remains liable for U.S. taxes on his share of partnership income. However, due to his long-term residence abroad, he may qualify for the Foreign Earned Income Exclusion (FEIE) under Internal Revenue Code (IRC) Section 911, which could exclude a certain amount of earned income, provided he meets the bona fide residence or physical presence test (IRS, 2022). Nevertheless, this exclusion does not apply to income from partnerships, and thus, his share of M&R’s profits would still generally be taxable in the U.S.

Furthermore, establishing a separate legal entity in Costa Rica introduces international tax considerations such as transfer pricing, withholding taxes, and double taxation treaties. Costa Rica taxes corporate income, and the new entity could be subject to local tax obligations on its worldwide income if it is considered tax resident. Additionally, profits repatriated from Costa Rica to the U.S. may be subject to withholding taxes, depending on the nature of repatriation and applicable treaty provisions. It’s crucial to consider whether the Costa Rican entity will be classified as a resident or non-resident for tax purposes, affecting its tax obligations.

From the Costa Rican perspective, the advantages of establishing a new entity include insulating the business from potential legal or fiscal liabilities associated with the existing partnership, and possibly benefiting from local tax incentives or lower corporate income tax rates. Costa Rica offers a relatively attractive tax regime for foreign investors, including tax incentives in free trade zones and potentially favorable tax treatment for certain types of income. Furthermore, a local entity can simplify compliance with Costa Rican regulations, establish a clear legal structure, and facilitate local operations and employment.

However, disadvantages exist as well. A new Costa Rican entity incurs additional administrative costs, registration fees, and compliance burdens. It also introduces complexities related to transfer pricing and profit shifting, which are scrutinized by tax authorities in both jurisdictions. The risk of double taxation arises if the income is taxed both in Costa Rica and the U.S., unless it is mitigated by tax treaties or foreign tax credits. Additionally, the legal separation might lead to increased reporting requirements and less flexibility in terms of management and profit distribution.

Another critical consideration revolves around the tax implications of Mike’s long-term residence and his significant involvement in the business. His physical presence and economic activity in Costa Rica might establish tax residency in Costa Rica, making him liable for local income taxes personally. Costa Rican tax law generally considers individuals as residents if they stay there for more than 183 days in a year, which Mike's extended stays would likely meet. This could subject his worldwide income to Costa Rican taxation and necessitate compliance with local tax regulations.

In conclusion, Mike’s decision to establish a new legal entity in Costa Rica involves a complex interplay of U.S. and Costa Rican tax laws. While it offers potential benefits related to local operations, legal liability, and incentives, it also introduces significant tax compliance, legal, and financial considerations. Engaging with legal and tax professionals specializing in international taxation is advisable to navigate treaty benefits, transfer pricing regulations, and reporting requirements to optimize the tax position and ensure compliance in both jurisdictions.

References

• Internal Revenue Service. (2022). Tax Guide for U.S. Citizens and Resident Aliens Abroad. IRS Publication 54.
• PricewaterhouseCoopers. (2023). Worldwide Tax Summaries: Costa Rica. PwC.
• OECD. (2021). Transfer Pricing Guidance and International Tax Frameworks.
• Hoffman, M. (2019). International Taxation: Cross-Border Issues for Multinational Businesses. Tax Notes International.
• Costa Rican Investment Promotion Agency. (2022). Doing Business in Costa Rica: Tax Incentives and Business Environment.
• Crane, P. (2020). Tax Planning and International Business Operations. Journal of International Taxation.
• United States-Costa Rica Double Taxation Treaty. (2018). U.S. Department of the Treasury.
• Tax Foundation. (2021). Global Corporate Tax Rates and Business Climate Comparisons.
• Campos, J., & Torres, M. (2019). Taxation of Foreign Investments in Central America. Central American Economic Review.
• Choi, S., & Han, S. (2020). Transfer Pricing Regulations in Latin America: Challenges and Strategies. International Tax Journal.