Letter from the Editor

by Brett W. Johnson

Dear Friend of Snell & Wilmer:

There is a tendency to expect that situations will be handled and that parties or different governmental agencies will act in a similar manner when all facts are essentially equal. However, in the global marketplace, a situation that would be easily resolved in the United States may not be so easily settled in a foreign country. For businesses that are operating abroad, it is important to understand the nuances of the country, region and legal jurisdiction in which you are active.

Several past issues of the Global Connection have concentrated on the United States’ perspective of doing business abroad. In this edition, we highlight the need to appreciate local foreign laws where a business is operating. Whether the deal involves purchasing real estate in Mexico, ensuring your intellectual property rights are secured or purchasing products that may be subject to anti-dumping penalties in the United States, the fact remains that in the global marketplace, laws and regulations from a variety of jurisdiction may come into play.

As referenced in two articles in this edition, countries are attempting to break down barriers to international trade and harmonize the laws. The G20, which met in Cabo San Lucas, Mexico (where Snell & Wilmer has a foreign office), is one example of international organizations dedicated to increasing and protecting international trade.

Snell & Wilmer appreciates the fact that, like its clients and friends, it is important to actually travel internationally to ensure that relationships are established to support future opportunities. To that end, we include a final letter from attorney John M. DeStefano III on his recent exchange to Great Britain. In addition to John’s experiences, attorneys Phillip Graves and Greer Shaw travelled to Asia to explore new opportunities. Attorney Anne Bishop also travelled to Great Britain to present at a conference on national security issues. Attorney Ray Jones was on a recent Arizona-sponsored delegation to Mexico. Attorney Barb Dawson is teaching at the Lex Mundi Institute, where attorneys from around the world gather to learn about international transactions and dispute resolution. Through these and other experiences and contacts, Snell & Wilmer is well-positioned to advise our clients on international matters.

As always, this Global Connection edition contains a wealth of information and we hope that it proves useful as you continue to seek out new global opportunities. Please feel free to contact me if you have any questions regarding information provided in Global Connection or if you would like to be included in future international events hosted by the Firm.

Best regards,

Brett W. Johnson
Editor

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Section 337: Tips for Discovery in ITC’s Rocket-docket

by Andrew S. Flior, Lindsey E. Martínez and Elizabeth M. Weldon

It’s 4:00 p.m. on a Friday and your client calls in a panic after sending you a complaint for patent infringement, along with a lengthy set of discovery requests. You think the client must have something wrong — surely discovery could not have started in a patent case if you have not even responded to the complaint? Upon inspection of the complaint, as well as a notice of investigation, however, you realize the client is correct as the case is pending in front of the International Trade Commission (ITC) — not a district court — and discovery responses are due in 10 days. Welcome to the fast-paced world of Section 337 investigations at the ITC.

General Overview of Section 337 Investigations
Section 337 investigations are conducted to guard against unfair competition in import trade, especially patent and trademark infringement. (19 U.S.C. § 1337.) The ITC does not award monetary damages, but has the unique ability to block infringing imports at the border. Investigations also differ from district court actions because they are heard by an administrative law judge, not a jury, and the Office of Unfair Import Investigations (OUII), who represents the public interest, typically assigns an OUII attorney to participate in the investigation.

The ITC is an increasingly popular forum to enforce intellectual property rights, with a record 69 investigations instituted in 2011 and 21 as of April this year. See article here. The popularity is due in part to the lightning speed at which the cases are conducted, with most investigations completed in less than 15 months. After the commencement of the investigation, which is triggered once a complainant files suit and the ITC serves notice, discovery is completed in four to six months, and the hearing is completed in nine to 12 months. The ITC forum is also particularly attractive for cases with foreign defendants as it has nationwide in rem jurisdiction over the products, not the parties, and nationwide subpoena power.

Best Practices for Section 337 Discovery
In Section 337 proceedings, discovery is conducted at breakneck speed. Respondents are often served with discovery requests just days after the investigation is instituted, with responses typically due within 10 days of service of the requests. Each ALJ prescribes his or her own set of “Ground Rules” to govern an investigation. However, there are certain uniformly critical areas in ITC discovery practice.

Volume of Discovery
Parties should be prepared for the rapid pace, volume and cost of discovery in the ITC, in the form of written responses, document production and depositions. Certain ALJs impose no limit on the number of requests for admission or requests for production, and they usually require responses within 10 days after service. Interrogatories are generally capped at 175, and parties must also usually respond within 10 days. OUII staff attorneys may propound written discovery on parties too. Document production is typically voluminous because importation is usually at issue — sometimes resulting in review of a large number of documents transmitted between domestic parties and foreign manufacturers. Although the ITC has reviewed the Federal Circuit’s model order designed to reduce e-discovery burdens, there is no word yet on whether or when the ITC plans to implement it or a similar provision.

Domestic Industry
Section 337 requires that complainants prove that a “domestic industry” exists related to the intellectual property at issue, which means there must be certain significant investments or employment in the U.S. related to that intellectual property. Domestic industry is often an early area of discovery as complainants may try to seek summary determination on this issue. Whether a domestic industry exists involves both economic and technical considerations. The economic prong looks at the extent to which the alleged domestic industry is utilizing the intellectual property right at issue in the U.S. The technical prong requires that the activities in the U.S. alleged to constitute a domestic industry actually utilize that right. This inquiry is highly fact-specific and may require engaging experts. For complainants, evidence of domestic industry should be gathered and vetted before the complaint is filed. Respondents should propound discovery to determine whether the domestic industry requirement has been met, because complainants must prove with specificity what portion of their U.S. activities and expenditures are directed toward the articles governed by the intellectual property rights at issue.

Foreign Language Discovery
Section 337 investigations often involve conducting e-discovery in one or more foreign languages. Parties must then decide how best to manage thousands of such documents, whether by enlisting client help, translators or knowledgeable attorneys. Parties must be careful with their review and their English translations of any such documents. While each ALJ has his or her own set of rules, many require that existing English language translations be produced. As opposed to practice in federal court, challenges to production of English language translations based on the work product privilege have been denied. Certain Microlithographic Machines and Components Thereof, Inv. No. 337-TA-468, Order No. 8 (June 11, 2002).

Use of Prior Art
In patent cases, many ALJs set a deadline for a respondent to provide notice of prior art on which it intends to rely. Exhaustive prior art searches should be performed and refined early in the case, because ALJs may take a narrow view of the “good cause” needed to amend this notice after the deadline. An ALJ recently denied a request to amend a prior art notice, relying on a prior warning to all counsel that “the fact that your expert couldn’t find the references is not adequate for good cause.” Certain Coenzyme Q10 Prods. and Methods of Making Same, Inv. No. 337-TA-790, Order No. 21 (Apr. 3, 2012). Respondents should also be careful to promptly distill their prior art to only references that will be used in the investigation. Notably, an ALJ recently struck respondent Apple Inc.’s voluminous notice of prior art, which included more than 7,000 entries on 380 pages, reasoning it provided “no notice at all” for complainant Samsung Electronics. Certain Elec. Devices, Including Wireless Commc’n Devices, Portable Music and Data Processing Devices, and Tablet Computers, Inv. No. 337-TA-794, Order No. 40 (Mar. 12, 2012).

Markman and Claim Construction
In the ITC, Markman hearings are not granted as a matter of course — neither Section 337 nor the relevant Commission Rules require that claims be construed prior to the final hearing. As such, certain ALJs defer claim construction until the final hearing and resolve all contested claim construction issues at that time. However, certain ALJs’ rules provide that a Markman hearing may be granted if beneficial to the investigation. Parties should therefore address a desire for a Markman hearing early at the scheduling conference with the ALJ.

Bonding
While monetary damages are not recoverable, information such as price, cost and profit may be discoverable, because, in the event the ITC finds a violation, it will set an importation bond. The ITC has used various approaches to determine the amount of the bond. One is to compute the bond amount based on an average of the amounts by which infringing imports undersell the complainant’s product. In other cases, the ITC has used a reasonable royalty rate, or imposed a 100 percent bond when no effective alternative information on pricing or profit existed.

Conclusion
Due to the intensity of Section 337 investigations and specifically the rapid pace of discovery, parties and practitioners need to be aware of this unique and fast-growing area of intellectual property litigation.

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Protecting International Rights in Domestic Legislative Processes

by Sara J. Agne and Nicole C. Burgmeier^[1]

It is no secret that “[b]ad law breeds unnecessarily hard cases.”^[2] In the international context, poor drafting or errant amendments to domestic legislation can result in ‘bad law’ that may impact interpretations of international treaty parameters or ineffectively accomplish waivers of sovereign immunity. The aim, then, is to affect the drafting of favorable law from the start.

Recent attention from the U.S. Supreme Court to manuals published by congressional legislative counsel as potential colors in the palette of statutory interpretation reveals the impact that even drafting style can have on legal interests.^[3] While legislative counsel generally provides ultimate input on the exact style of draft legislation introduced in Congress, the current climate suggests that those who continue to hold to the old maxim that laws are like sausages—it’s best not to see them being made—are missing out.

Domestic legislative drafting appears to increasingly result from a collaborative process amongst stakeholders, their counsel, and lawmakers and their counsel. Political advocacy group Freedom Watch, Inc., has even sued in federal court to determine just how much of the Patient Protection and Affordable Care Act was drafted in collaboration with interested parties.^[4]

No matter who the drafter is, the first step is the same: discern the objective. Thus, it is important at this stage that a client clearly state the goal for a piece of proposed legislation. In the international context, a client must emphasize legal theories that must be legislatively approved. A clear example of this is a waiver of sovereign immunity.

Sovereign immunity is the concept that the federal government is immune from suit without its express permission. The U.S. Supreme Court has noted that “a waiver of sovereign immunity is to be strictly construed, in terms of its scope . . . [and must be] ‘unequivocally expressed’ in a statutory text.”^[5] In the legal context, these rules are known as ‘clear statement rules.’ Such rules are intended to enhance the predictability of statutory interpretation and trim the cost involved in legislative drafting. The importance of these rules cannot be understated, as courts require that the statute’s language be clear for a waiver of federal sovereign immunity to be effective. Clear statement rules should be considered in any legislative drafting effort that seeks a waiver of governmental immunity.

Additionally, congressional counsel and the vast majority of states, have published bill drafting manuals that provide a framework for legislative drafting. These manuals provide guidelines on style and mechanics to drafters to ensure laws are consistent in tone and appearance.

As noted above, the importance of drafting manuals in the interpretation of statues seems to be growing. Prior to 2010, the U.S. Supreme Court had only acknowledged such manuals once. While these manuals generally focus on style, rather than content, the Court’s increased attention reflects that style often informs the interpretation of substance.

Those with international interests who may require protection or enhancement via domestic legislation should recognize the importance of familiarity with the above processes. Where appropriate, knowledgeable counsel experienced with the style mandated by such manuals can assist in developing draft legislation to properly affect waivers and protect international transactions or interests at all legislative levels.

______________

Notes:

^[1] Co-authorship credit goes to Snell & Wilmer summer associate Nicole C. Burgmeier for assisting in writing this discussion. [back]

^[2] Ruth Bader Ginsburg & Peter W. Huber, The Intercircuit Committee, 100 Harv. L. Rev. 1417, 1417 (1987). [back]

^[3] See, e.g., United States v. O’Brien, 130 S. Ct. 2169, 2180 (2010); Carr v. United States, 130 S. Ct. 2229, 2244-45 (2010). Prior to 2010, the Court had only acknowledged drafting manuals once, in Koons Buick Pontiac GMC, Inc. v. Nigh, 125 S. Ct. 460, 467 (2004). [back]

^[4] Freedom Watch, Inc. v. Obama, et al., 1:09-cv-02398 (D.D.C.). [back]

^[5] See Dep’t of Army v. Blue Fox, Inc., 525 U.S. 255, 261 (1999). [back]

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Understanding the “Dos and Don’ts” of a Foreign Trade Zone

by Brett W. Johnson and Matt Jarvey^[1]

Imagine a corporation in the business of building and leasing warehouses to manufacturers, in particular, manufacturers that import raw materials to be manufactured here in Arizona. The hypothetical corporation owns a large plot of undeveloped land in Maricopa County upon which it would like to construct a warehouse. But, in order to build the warehouse, it needs construction financing and tenants who are willing to pre-lease space in the warehouse. The corporation needs to make its property as attractive as possible to would-be manufacturing tenants. But how?

Now imagine a manufacturer in the business of assembling goods. While it produces final goods in the United States, most of its raw materials are imported from outside the country and are subject to tariffs. Moreover, the tariffs on the imported raw materials are higher than the tariffs on the final product. The manufacturer needs to find cost saving measures that will help it compete in a globalized market. What can it do?

In either case, a “foreign trade zone” (FTZ) could be the answer. FTZs are physical zones in the United States that are considered to be outside the country for the purpose of assessing duties and tariffs against businesses within the zone. Thus, manufacturers that import raw materials from outside the country stand to benefit from duty eliminations, duty deferrals, duty reductions and other logistical benefits that come with operating within an FTZ. There are also state property tax benefits conferred by Arizona upon FTZ users.

The process of granting FTZ status is overseen by the FTZ Board in Washington, D.C. The Board grants authority to establish FTZs to local authorities that deal directly with FTZ applicants. In Arizona, the City of Phoenix is one of the local authorities, or “grantees,” with the power to sponsor local applications for FTZ status. Accordingly, applicants apply for FTZ status to the FTZ Board through the City of Phoenix.

But the process of obtaining FTZ status can be fraught with roadblocks and red tape for the unprepared developer. While every corporation’s path to FTZ status will present unique challenges, the following are some common “Dos” and “Don’ts” to keep in mind when pursuing FTZ status.

1. Do decide whether to pursue a “magnet site” or a “usage driven site”

A corporation could apply to become one of two different types of FTZs: a magnet site or a usage-driven site. A magnet site is a site designed to cover multiple users who will all independently operate on one FTZ site. A usage-driven site covers only one user, regardless of whether that user operates on a site with other businesses.

The current trends in Arizona favor usage-driven sites over magnet sites for a number of reasons. First, the FTZ Board, as well as many local grantees, including the City of Phoenix, have implemented a streamlined application procedure called the “Alternative Site Framework” (ASF). The ASF was designed to make it easier and faster for applicants to achieve FTZ status. The FTZ Board’s goal was to minimize speculative application filings by developers who wanted to get pre-approved FTZ sites, even though there were no actual users to occupy the site.

Second, it will likely be harder for a Phoenix applicant to get magnet site approval. The City of Phoenix limits the number of magnet sites to six. Five have already been granted and one is pending. Phoenix will consider additional applications for magnet sites, but because the magnet sites are currently at or near the limit, the city will more carefully scrutinize whether the current magnet sites are being used to their capacity before granting additional magnet sites. Usage driven sites, however, are unlimited.

Third, unless a magnet site applicant has a specific user on board to begin operations in the FTZ, there is a risk that the magnet site’s FTZ status will lapse before the applicant can bring in any users. An approved magnet site’s FTZ status will lapse after five years unless a user activates its operations within the FTZ.

Finally, a magnet site applicant must have an “operator” ready to oversee the recordkeeping and daily operations of the site. This may be the applicant itself or a third party, but it may be difficult to find an operator willing to oversee an entire magnet site’s operations. While a usage driven site also must have an operator, usually the individual user becomes their own operator.

2. Don’t confuse an FTZ’s tariff benefits with Arizona’s property tax benefits

Businesses in an FTZ receive both tariff and state property tax benefits, but the benefits come from different places. Tariff benefits come from federal law and are regulated at the federal level. These benefits include increased cash flows from duty deferrals, duty elimination for re-exported goods, inverse tariffs on final goods manufactured in an FTZ and other logistical benefits coordinated by Customs and Border Protection (CBP).

State property tax benefits, on the other hand, are a product of state law and operate independent of federal tariff benefits. Arizona incentivizes FTZs by reducing the property tax applicable to businesses inside the zones by 75 percent. But be careful, an FTZ must be “activated” by CBP before a user can realize these tax benefits.

3. Do get permission from the local tax authorities

FTZ applicants need more than the City of Phoenix’s permission to operate an FTZ; other local tax authorities (e.g., school districts, water districts, fire districts, etc.) must also give their blessings. This process can be time-consuming, especially if there are many local tax bodies covering the same site.

4. Don’t plan on using FTZ status to avoid paying your current property taxes

While Arizona law provides a property tax incentive to FTZ users, FTZs are not intended simply to be a means to lower a business’s property taxes. For example, the City of Phoenix will not provide any support for a business attempting to take advantage of Arizona’s tax benefits for pre-exiting real property. It is far easier for FTZ applicants to get approved for Arizona’s property tax benefits covering soon-to-be constructed real property.

5. Do get a user on board early

An applicant’s FTZ status must be both “approved” and “activated” before the applicant can receive preferential state tax treatment. Activation is achieved through a separate application to CBP. An approved magnet site can remain inactivated for up to five years before the approval lapses. A usage-driven site can remain inactivated for three years.

6. Do have a “tariff rationale” ready

It is critical that any FTZ applicant have a tariff rationale—an economic justification for why the applicant should be granted FTZ status. Good tariff rationales are those that demonstrate how an FTZ status will help the applicant better compete in a global marketplace or increase its hiring capacity for domestic labor.

Applicants should pay particular attention to leveraging an FTZ’s inverse tariff benefits. An inverse tariff allows a manufacturer operating inside an FTZ to pay the tariff rate applicable to its final product, rather than that applicable to its raw materials. This is useful to manufacturers whose imported raw materials carry a higher duty rate than the final products that are manufactured in the FTZ.

7. Do prepare for lots of paperwork

An FTZ applicant must complete a number of detailed applications. The process can take more than 15 months to complete.

8. Do make sure the benefits of FTZ status will outweigh the costs

A potential FTZ applicant might be blinded by the promise of lower duties, tariffs and property taxes that come with operating in an FTZ. But there are costs associated with an FTZ status, too. These costs include the cost of complying with CBP regulations and maintaining the necessary records required of FTZ manufacturers. There can also be additional security, software, administrative, legal and customs costs depending on the type of FTZ user. Potential FTZ applicants should prepare a detailed cost-benefit analysis of obtaining FTZ status before deciding to apply.

Conclusion:
FTZ status has the potential to confer a number of benefits on businesses that regularly deal with imports, duties and tariffs. But the process of applying for and obtaining an FTZ status can be complicated and time-consuming. It is important that any business, whether a land developer or a manufacturer, fully understands the application process and how it will affect their operations.

______________

Notes:

^[1] Matt Jarvey is a summer associate for Snell & Wilmer and a third-year law student at Drake University School of Law. [back]

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Commerce Preliminarily Finds High Dumping Margins for Solar Cells from People’s Republic of China

by Richard C. Katz

In October 2011, a group of U.S. domestic producers, led by Solar World Industries America of Hillsboro, Oregon, filed a petition for the institution of antidumping and countervailing duty investigations against crystalline silicon photovoltaic cells and modules from China. On May 17, 2012, the U.S. Department of Commerce (Commerce) announced its preliminary determination in the antidumping portion of the investigation, finding that Chinese producers sold solar cells in the United States at dumping margins ranging from 31.14 percent to 249.96 percent of the freight on board (f.o.b.) price.

Chinese respondents in the case, Wuxi Suntech and Trina Solar, received preliminary dumping margins of 31.22 and 31.14 percent, respectively. Fifty-nine other Chinese exporters qualified for a separate rate of 31.18 percent. All other Chinese producers/exporters received a rate of 249.96 percent. Commerce will now advise U.S. Customs & Border Protection (CBP) to collect a cash deposit or require a bond in the amount of the dumping margins applicable to all entries of these products made up to 90 days prior to late May 2012 (i.e., all entries made after late February 2012).

Combined with prior Commerce countervailing duty determinations in March, the preliminary dumping findings will result in the imposition of duty deposit rates of between 35 percent and 255 percent (depending upon the producer/exporter). Obviously, these significant duty deposit requirements will have a major impact on prices of imported Chinese solar panels.

The U.S. antidumping law provides for the imposition of increased import duties on products sold to the United States at unfairly low prices, thereby injuring competing U.S. manufacturers and their labor force. The U.S. countervailing duty law provides for increased duties on products sold to the United States benefitting from illegal export subsidies. The Solar World petition alleged both predatory pricing and illegal subsidies by the Chinese industry, which is why separate duty deposit requirements were imposed in March and May, respectively.

Products: The products covered by the investigation are crystalline silicon photovoltaic cells and modules, laminates and panels, consisting of crystalline silicon photovoltaic cells, whether or not partially or fully assembled into other products, including, but not limited to, modules, laminates, panels and building integrated materials.

Critical Circumstances: Commerce has preliminarily determined that “critical circumstances” exist in this case. Therefore, both the May 2012 antidumping finding and the March 2012 countervailing duty finding will include a 90-day retroactive duty assessment.

Next Steps: Commerce is currently scheduled to make its final determination in the dumping case in early October 2012. If the Commerce's final determination is affirmative and the U.S. International Trade Commission then confirms its preliminary injury finding, an antidumping order against these products will be imposed by Commerce. The final dumping margins may be different than the announced preliminary rates, either lower or higher.

Industry Reaction: Outside the confines of the trade case itself, the Chinese government has threatened to take retaliatory action against various U.S. exports to China, including U.S.-sourced polysilicon used in the manufacture of the Chinese panels. In addition to the U.S. trade case, solar panel manufacturers in India are petitioning their government to impose increased tariffs on both U.S. and Chinese products. And in a separate U.S. filing, the wind power industry has sought increased tariffs against wind towers from China and Vietnam. The U.S. solar installation industry, which, to a great degree depends on low-priced Chinese imports, is extremely upset about the dumping finding, claiming that it will lead to a loss of installer jobs. Whatever the ultimate outcome of the U.S. solar panels trade case, it already caused a good deal of disruption in the world-wide alternative energy industry and soured U.S.-China trade relations.

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Practical Tips for U.S. Persons Owning Mexican Property Thru a Fideicomiso

by William A. Kastin, Carlos A. Sugich, Mark A. Ziemba and Carlene Y. Lowry

Every time I’m presented with a contract, I’m quickly transported to a small room in which Willy Wonka, played by Gene Wilder, is vehemently scolding the good natured Charlie Bucket and the poor, protective Grandpa Joe:

“Under section 37B of the contract signed by him, it states quite clearly that all offers shall become null and void if — and you can read it for yourself in this photostatic copy — ‘I, the undersigned, shall forfeit all rights, privileges, and licenses herein and herein contained,’ et cetera, et cetera... ‘Fax mentis incendium gloria cultum,’ et cetera, et cetera... ‘Memo bis punitor delicatum’!!! It’s all there, black and white, clear as crystal!! You stole fizzy lifting drinks! You bumped into the ceiling which now has to be washed and sterilized, so you get nothing! You lose! Good day sir!”

I wish all U.S. persons looking to purchase Mexican property through a fideicomiso would remember that scene before doing so, because failing to pay attention to the applicable rules could result in being on the receiving end of a similar rant from someone much less playful than Mr. Wonka.

This article is not intended to discourage U.S. individuals from investing in Mexican property through a fideicomiso. Instead, we wish to provide U.S. individuals a general “heads up” regarding certain issues to consider when owning Mexican property through a fideicomiso. Although the article unavoidably addresses U.S. tax matters, it is directed toward individuals who do not have a tax background. In addition, any U.S. person seeking to own Mexican property through a fideicomiso should consult with their U.S. attorney who will need to either (i) be licensed to practice law in Mexico, or (ii) coordinate the transaction through Mexican legal counsel.

I. General

As many of you already know, Mexican law prohibits U.S. individuals and entities from owning a direct interest in Mexican residential land located within 30 miles of Mexico’s coastline, or within 60 miles of Mexico’s international borders. However, a U.S. individual or entity can own such property indirectly through a Mexican real estate trust known as a fideicomiso.

II. What is a Fideicomiso and Why You Should Care?

Although no one can say with certainty, a fideicomiso has often been treated by the IRS as a trust for U.S. tax purposes and almost always as a grantor trust. This conclusion stems from the facts that:

• a fideicomiso must have a Mexican person who holds powers and obligations similar to those of a trustee, and

• usually a U.S. individual (i) funds the acquisition of the Mexican property held in the fideicomiso, (ii) has the right to cause the sale of such property, and (iii) is entitled to receive the proceeds from such sale.

However, to date, the IRS has not made a definitive statement on the U.S. tax treatment of fideicomisos. Because the treatment of a fideicomiso as a foreign grantor trust is not well settled, this article also provides food for thought for those readers who believe that a fideicomiso should be treated simply as a foreign trust (but not a foreign grantor trust).^[1] Once you label the fideicomiso — whether as a foreign trust or a foreign grantor trust — you can start to consider the applicable U.S. rules.

A.  Assuming the Fideicomiso is Treated as a Foreign Grantor Trust

A fideicomiso treated as a foreign grantor trust results in the U.S. individual being treated as the owner of the assets held in the fideicomiso for U.S. tax purposes. As such, the U.S. individual’s use of the property held in the fideicomiso would be treated the same as if the individual was using his or her own property, and so there would be no U.S. income tax implications whatsoever.

Notwithstanding the federal income tax treatment discussed above, if a fideicomiso is treated as a foreign grantor trust, then the U.S. grantor must make sure that both IRS Forms 3520 and 3520-A are filed, generally on an annual basis. These forms are generally required upon the transfer of property to, and the use of property held by, a fideicomiso. The penalties for failing to file these forms can be significant (e.g., the greater of 35% of the gross value of the property transferred to the fideicomiso and 5% of the gross value of the fideicomiso’s assets). If you already have a fideicomiso and have not filed these forms, all is not lost. These penalties may be avoided if the grantor can demonstrate that the grantor’s failure to file the forms was due to reasonable cause. You should consult with your tax advisor about whether you should file these forms right away.

Additionally, from a U.S. estate tax perspective, if a fideicomiso is treated as a foreign grantor trust, then all of the property held in the fideicomiso will be included in the grantor’s estate upon his or her death. And surprising to many, any appreciation in the Mexican property occurring between the acquisition of the property by the fideicomiso and the U.S. grantor’s death may be subject to U.S. income tax at the time of death.

B.  Assuming the Fideicomiso is Treated as a Foreign Trust (but not a Foreign Grantor Trust)

For those readers who believe a fideicomiso is not a foreign grantor trust, the question of whether a U.S. grantor should file IRS Forms 3520 and 3520-A can be considered along the following lines. One available option is to file these forms on a “protective” basis. Under this approach, if it turns out that the forms are not required, then there is a risk that the grantor would have over-disclosed to the IRS the ownership and activities of the fideicomiso. However, there appears to be no significant downside arising from such over-disclosure.^[2] Alternatively, you could choose not to file these forms. Under this approach, if it turns out that the forms are required, the risks for failing to file these forms are relatively large and may never go away.^[3] In light of the IRS’ heightened and continued scrutiny of foreign holdings by U.S. persons, it appears imprudent to not file these forms.

One of the issues with treating a fideicomiso as a foreign non-grantor trust is that the U.S. tax consequences are simply not clear and present many unanswered questions and potential traps. For example, it is unclear how to treat payments (e.g., mortgage or maintenance payments) by a U.S. person to, or for the benefit of, the non-grantor foreign trust fideicomiso. Such payments may be considered as taxable gifts, rent or as some other type of payment depending upon the overall facts and circumstances. In addition, as discussed immediately below, the uncompensated use by a U.S. person of the property held in a non-grantor trust fideicomiso presents additional questions.

1. New Information Reporting Requirements When a Beneficiary Uses Property Held in a Fideicomiso

If a U.S. individual (i) is a beneficiary of a fideicomiso, and (ii) uses the Mexican property held in the fideicomiso without actually paying fair value for such use, then the IRS will treat that use as a distribution from the fideicomiso to the beneficiary .^[4] Clearly the use of property is not an actual distribution of cash to the beneficiary. However, recent law treats such use as a payment or distribution in kind to the beneficiary of the right to use the property held in the fideicomiso. Presumably, the value of the distribution would be calculated as the fair rental value of the property used. And if the value of the underlying property is considerable — as is the case with many ocean-front properties — then the property’s fair rental value would be calculated accordingly.

For example, if a beneficiary pays fair rental value of $20,000 to use property held in a fideicomiso, then there would be no distribution from the fideicomiso to the beneficiary. Alternatively, if the beneficiary did not pay anything for the use of such property, then the fair rental value is treated as having been distributed to the beneficiary. In such a case, in connection with a distribution from the fideicomiso, Forms 3520 and 3520-A must be filed, and in certain instances the value distributed may be taxable to the recipient. Failure to file these forms could result in significant penalties (e.g., the greater of $10,000 or 35% of the gross value of the distribution received from the fideicomiso). In this case the penalty for failing to file either form would be $10,000.^[5]

2. New Information Reporting Requirements When a Third Party Uses Property Held in a Fideicomiso

If a U.S. individual is not a beneficiary of the fideicomiso, then things get even more complicated. In such a case, one should look to the relationship between (i) the individual using the property held in the fideicomiso, and (ii) the beneficiary of the fideicomiso. Use of the property would then be analyzed in two steps.

“Step 1” of the arrangement could be characterized as an in-kind distribution from the fideicomiso to the beneficiary. This in-kind distribution would be subject to reporting and potential tax implications discussed above, the same as if the beneficiary used the property directly (e.g., Forms 3520 and 3520-A must be filed).

“Step 2” of the transaction could be characterized as a transfer of the in-kind distribution from the beneficiary to the individual using the property. If a business relationship exists between the individual using the property and the beneficiary, then the use of the property may be treated as compensation to the individual using the property. Again, the value of the compensation would be calculated as the fair rental value of the property used. If it’s not a business relationship, then the transaction arising from this “Step 2” could be treated as a gift by the beneficiary to the individual, the tax implications of which should be considered after consulting with your advisor.

Finally, from a U.S. estate tax perspective, even if the fideicomiso is determined to be a foreign non-grantor trust, it is likely that the U.S. grantor will have retained powers and rights sufficient to cause inclusion of the property in their U.S. estate.

III. Additional Disclosure Requirements

1. Mexican Bank Accounts

If, in connection with owning Mexican property through a fideicomiso, you open a Mexican bank account (e.g., to pay property-related expenses), then you may be required to disclose to the IRS the existence of that account. In general, U.S. individuals are required annually to report a direct or indirect financial interest in, or signature authority over, a financial account maintained in a foreign country if the aggregate value of all such accounts exceeds $10,000 at any time during the year. Such reporting is disclosed on Form TD F 90-22.1, also known as an “FBAR.”

The general civil penalty for failing to file an FBAR depends upon whether the failure is “willful.” If the failure is willful, the penalty for failing to file the FBAR is generally the greater of $100,000 or 50% of the highest aggregate balance of all foreign accounts during the year, per annual violation. For example, if a Mexican bank account maintains a $100,000 balance for three years and you willfully fail to disclose the account to the IRS in each of those years, then the penalty could be $150,000 (i.e., $50,000 for each year). Additionally, and perhaps more importantly, the failure to report such accounts also carries the risk of criminal prosecution.

If the violation is not willful, then the penalty is reduced to no more than $10,000 per violation. Note that the penalty for failing to file an FBAR is in addition to the penalties and interest that apply to any underreporting of income for federal income tax purposes.^[6]

2. Mexican Property Worth More than $50,000

In general, for tax years 2011 and beyond, U.S. taxpayers must annually disclose foreign financial assets if those assets exceed $50,000 in value. Assets held in a foreign trust, presumably including a fideicomiso, are included as assets required to be disclosed. This disclosure must be made on IRS Form 8938. Failure to timely file a Form 8938 may result in a $10,000 penalty. In addition, if you underpay your tax as a result of a transaction involving an undisclosed specified foreign financial asset, then you may have to pay a penalty equal to 40% of that underpayment.^[7]

IV. Conclusion

Although these rules are complicated, the issues addressed throughout this article are manageable at every level if properly and timely addressed. If you own or are considering owning Mexican property by way of a fideicomiso, you should discuss these issues with your legal and tax advisors in both the U.S. and Mexico. Failure to follow applicable law may not lead to the same fate as those who broke the rules in Willy Wonka’s Chocolate Factory, but the penalties could still be significant.

To ensure compliance with Treasury Regulations governing written tax advice, please be advised that any tax advice included in this communication, including any attachments, is not intended, and cannot be used, for the purpose of (i) avoiding any federal tax penalty or (ii) promoting, marketing, or recommending any transaction or matter to another person.

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Notes:

^[1] Other alternatives respecting the U.S. tax treatment of a fideicomiso (e.g., as an agency relationship) are not discussed in this article. [back]

^[2] If you have failed to file in the past, then you should consult with your tax advisor the implications that such a protective filing may have on your treatment in prior years. [back]

^[3] If the forms are required to be filed, but are not timely filed, then the statute of limitations does not begin. [back]

^[4] See, Code §643(i) (addressing uncompensated use of property held by a foreign non-grantor trust). [back]

^[5] The penalty is the greater of (i) 35% of the fair rental value deemed distributed (i.e., 35% x $20,000, which is $7,000), or (ii) $10,000. In addition, separate penalties apply for each failure to file a Form 3520 and each failure to file a Form 3520-A, and each penalty could arise for each year that the applicable forms are not filed. [back]

^[6] The IRS recently announced an offshore voluntary disclosure program (the “2012 OVDP”) to bring people back into compliance who failed to report an interest in, or signature authority over, one or more offshore financial accounts. The penalties otherwise applicable for failing to file FBARs may be reduced under the 2012 OVDP. See our January 10, 2012 Legal Alert. [back]

^[7] In certain circumstances additional penalties, including criminal prosecution, may apply. [back]

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G20 in Los Cabos

by Carlos A. Sugich

The Group of Twenty (also known as the “G20”) met in Los Cabos, Baja California Sur under the G20 Mexican Presidency from June 18-19, 2012. The G20 is the premier forum for international cooperation on important aspects of the international economic and financial agenda and brings together the world’s major advanced and emerging economies.^[1] The 2012 G20 Leaders’ Summit in Los Cabos brought together in Los Cabos 24 heads of state and government and eight leaders of international organizations. It was the seventh meeting of the G20 and the first one held in Latin America.^[2]

The G20 includes 19 country members and the European Union, which together represent approximately 90 percent of the global gross domestic product, 80 percent of global trade and two-thirds of the world’s population.^[3] The objectives of the G20 are: (1) policy coordination between its members in order to achieve global economic stability and sustainable growth; (2) to promote financial regulations that reduce risks and prevent future financial crises; and (3) to create a new international financial architecture.^[4] The Leaders’ Summit was held with these objectives in mind.

At the outset of its presidency, Mexico established several priorities that helped to shape the Leaders’ Summit and lay the foundation for the agreements reached. The priorities were: (1) economic stabilization and structural reforms as foundations for growth and employment; (2) strengthening the financial system and fostering financial inclusion to promote economic growth; (3) improving the international financial architecture in an interconnected world; (4) enhancing food security and addressing commodity price volatility; and (5) promoting sustainable development, green growth and the fight against climate change.^[5] Mexico encouraged not only member participation in accomplishing these priorities, but also the participation of non-members, international organizations and the private sector in order to meet its objectives.^[6]

Discussions at the Los Cabos summit centered primarily on the issues of European stabilization, financial regulatory reform, International Monetary Fund (IMF) reform and resources, job growth and economic vulnerability.^[7] The summit produced four documents, which summarize the agreements reached: (i) The Leaders Declaration; (ii) The Los Cabos Growth and Jobs Action Plan; (iii) Policy Commitments for each G20 country; and (iv) the 2012 Progress Report of the Development Working Group. In addition, the Business 20 (B20) produced a set of Task Force Reports, and the Labour 20 (L20) produced a short report and engineered a joint B20-L20 meeting with G20 leaders.^[8]

The following are some of the important agreements reached by the G20 leaders in order to address several of today’s economic challenges:

• The leaders signed the Los Cabos Action Plan for Growth and Employment. The plan established commitments to deal with the Eurozone; strengthen demand, economic growth and financial systems; ensure the fiscal consolidation of advanced economies; reinforce solid, sustainable growth in emerging economies; and maintain trade liberalization.

• The IMF’s financial resources were increased to over $450 billion USD. This is the greatest capitalization in the history of the Fund, which will increase its capacity to provide support and loans for coping with economic crises.

• The leaders adopted trade facilitation measures in order to reject protectionism because it is in the interest of all the Group members to prevent further recession. The main agreement was to extend the Stand Still Clause to 2014, which involves abstaining from implementing protectionist measures and will guarantee certainty for international markets.

• Advancements were achieved in improving the regulatory framework in order to strengthen financial systems. Progress was made in the creation of an institutional framework, as a result of which the Financial Stability Council will be created, with new statutes to enhance its operation and governance.

• In regard to financial inclusion, agreements were reached for the Global Alliance for Financial Inclusion, which will measure the progress of the extension of financial services to the population with the least resources. In addition, greater financial education will be promoted and protective measures increased for the users of financial services for savings, credits and insurance.

• In regard to food security, the G20 agreed to promote greater public and private investment in order to promote agriculture, develop technology and increase the productivity of the sector. The president announced that Mexico will host the G20 Agricultural Chief Scientists in September. An Agricultural Market Information System will be created to prevent worldwide food price speculation.

• For the first time ever, environmental issues were discussed. In particular, Mexico promoted the discussion of topics such as green growth, the elimination of fossil fuel subsidies and measures to increase fuel efficiency, among others. The president declared that this would be one of the legacies of the VII Leaders’ Summit.^[9]

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Notes:

^[1] What is the G20?, G20Mexico.org. [back]

^[2] G20 Leaders’ Summit Inaugurated; Previous Leaders’ Summits, G20Mexico.org. [back]

^[3] Id. [back]

^[4] Id. [back]

^[5] Mexican Presidency of the G20, G20Mexico.org. [back]

^[6] Id. [back]

^[7] View from the Ground at the Los Cabos Summit, CIGI.org. [back]

^[8] G20 Mexico 2012, G20Mexico.org. [back]

^[9] G20 Leaders Declaration, (2012). [back]

Los Cabos: More Than a Holiday Destination

by Carlos A. Sugich

Los Cabos is known as a world-class tourist destination but it was all business and diplomacy from June 18-20 when it hosted the first ever G20 Leader’s Summit. When Mexico assumed the presidency of the G20, it took on the responsibility of hosting the 2012 Leaders’ Summit. It was no surprise that President Felipe Calderón chose Los Cabos as the site for this influential meeting of world leaders because of its prominence in Mexican tourism, strong economic contributions, friendly regulatory environment, and overall safety.

Presidents Obama and Calderón are pictured below in Los Cabos.

Heads of government and finance ministers from the European Union and 19 of the most economically influential countries in the world^[1] met in Los Cabos to discuss pressing international financial issues regarding economic stabilization, strengthening the financial system and promoting sustainable development.^[2]

Together with the Leaders’ Summit, Los Cabos also hosted the Business-20 Summit (B20). The B20 is an international forum aimed at fostering dialogue between governments and the global business community. The B20’s main objective is to provide heads of state and other government leaders of the G20 with meaningful recommendations from the private sector, which could contribute to the achievement of its objectives of global economic growth and social development. The B20 is integrated by CEOs and chairmen of leading global companies, as well as experts from international organizations and universities, who convene to discuss and generate recommendations that are eventually presented to the government leaders of the G20.

It is no secret that Los Cabos’ success as a tourism destination has been accompanied by international development activity. Over the years, Los Cabos and the Baja area have been a magnet for foreign direct investment mainly from investors based in the United States, Canada and Spain. Whether it is the financing and development of hotels and resorts or the construction of marinas, master planned communities and large infrastructure projects, this area has seen billions of dollars in foreign direct investment over the years from some of the largest and most successful companies in the world.

The same qualities that made Los Cabos the ideal location for the G20 Leaders’ Summit and its members were also some of the reasons behind Snell & Wilmer’s decision to open its first international office in Los Cabos back in 2008.

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Notes:

^[1] Members, G20Mexico.org. [back]

^[2] Mexican Presidency of the G20, G20Mexico.org. [back]

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A Letter Home Part II: My Visit with the English Inns of Court

by John M. DeStefano III

In April, Global Connection published Snell & Wilmer attorney John DeStefano’s first “Letter Home” from London. John was selected by the American Inns of Court as one of two Pegasus Scholars who visited the barristers and courts of the United Kingdom in 2012. What follows is the concluding account covering the second half of his visit.

My new commute is to Holborn, which has a completely different feel from Temple. Whereas Fleet Street was lined with legal bookstores, shops selling wigs and tunics, and barristers in transit with flowing robes, Holborn feels more like Main Street, or as they say here, the High Street. Commuters jostle one another on the sidewalks. London often feels like a huge cluster of urban villages, but here the rows of tall city buildings could pass for a New York City block. One would scarcely know that 20 paces to the north sit the walled-in, secret gardens, ringed with Georgian buildings like a New England college quad. The gardens are closed most hours of the day and guarded by a dragon effigy—this is Gray’s Inn. To the south lies another clearing too, dominated by the massive Hall of Lincoln’s Inn, which stands across from a chapel holding a great bell brought back from the conquest of Cadiz in 1596.

This new neighborhood is where I will spend the second half of my Pegasus Scholarship sojourn. My first workplace at the Inner Temple dated back to Sir Christopher Wren. The structures of Gray’s Inn have a more recent but no less dramatic provenance, rebuilt after their near-total destruction in the Blitz of World War II. Tracing the history of my new office building back a bit further, one finds that it was once home to the law firm that employed Charles Dickens as a clerk, cementing that man’s lifelong loathing of the law trade. That firm appears to be long gone, as are many of the procedural pestilences that afflicted 19th century English legal culture. (Unburdened by a written constitution, English law reform moves more quickly than our own in many areas.) Looking out the window down at the gardens, I take in the same view Dickens might have had when, as a young legal trainee, he tossed cherry pits into the welcoming hats of passers-by.

Here my work focuses on a new subject area: English media and privacy law. In America, the Supreme Court’s decision in New York Times v. Sullivan makes high-profile libel lawsuits relatively rare because it requires public figure plaintiffs to prove reckless disregard of the truth. Parliament has not limited the rights of public figures in this way. Each year, a few hundred libel actions are filed in the High Court and pursued, vindicating either the right of the media to print what it will, or the right of the private individual to his good name. Whatever the result, the English rule of shifting attorney’s fees to the losing party keeps the stakes, often enough, very high. Free speech advocates complain that these lawsuits, or even the threat of such suits, unduly chill the vigor of investigative journalism. A handful of recent lawsuits by wealthy foreigners—who purposely choose the London forum for the leverage it provides against publishers—have prompted a reexamination of English libel rules and led to various reform proposals in Parliament.

If you travel into the deepest reaches of the Royal Courts of Justice, that sprawling fairytale fortress on Fleet Street, you will find a source of less-friendly sentiment toward the press. Here, at the end of the labyrinth of passageways leading to Courtroom 73, Lord Justice Leveson has convened his inquiry into the phone-hacking scandal and its aftermath. One need not observe many hours of these hearings to understand how serious the issues under review. The ability of concentrated media forces to improperly influence politicians and police has stoked a national outrage that counteracts the modest push for more press-friendly libel laws. Shocked by the willingness of media agents to tap and invade the private lives not just of celebrities, but also of a child kidnapping victim and the families of Iraq war dead, the British public has run out of patience with journalistic abuses. Lord Justice Leveson has spent months in this inquiry and will spend more months yet, hearing testimony from witnesses, malefactors, titans, pawns and victims, in aid of an overall report and response proposal.

In America, we grow up cherishing our stake in the First Amendment, which includes a free press. The idea of calling on the government and courts to regulate what our papers print seems unfamiliar. England has not surrendered that idea, though one hardly thinks of that place, which gave birth to the liberated thoughts of John Milton and John Stuart Mill, as a repressive environment for free thought and expression. Many lawyers see America’s First Amendment jurisprudence as a point of national pride; it need not dampen that appreciation to realize, as English lawyers and judges like to point out, that we seem to be the only country in the world that follows the New York Times v. Sullivan rule.

In my last weeks of work at Gray’s Inn, I finish making the rounds for lunch in the various Inns of Court dining halls. Lincoln’s Inn Hall with its brightly painted beams seems to be illuminated by the overhanging portraits of the “fire judges,” the judges who sat without pay for months to sort out the chaos of property disputes after the Great Fire of London in 1666. The cavernous Middle Temple Hall with its double-hammer beam roof makes everyone think of Harry Potter. Gray’s Inn Hall is more subdued, dimly lit, and not altogether crowded the day of my visit. The crowd sits outside in the dragon-guarded gardens, miraculously opened to the public for just a few hours at lunchtime. They picnic among the plane trees and hordes of bright yellow daffodils. I am equally lucky to share in the idyllic hospitality of the Inns for what has proven to be a very short six weeks.

John returned from his trip in April. His complete report on the Pegasus Scholarship experience can be found on the American Inns of Court website.