Using "Magic Black Box" Concept
A. OCC Plan™ uses the "Magic Black Box" concept of creating
a series of separate legal entities to manage and control the investment
and flow of income and expenses regarding business operations in a foreign
country.
B. Example: Owner and Partner each own a 50%
interest in venture. The venture will be located in a foreign country.
Instead of investing directly in the foreign country, Owner and Partner
create several "Black Boxes." - entities, such as limited
liability companies (LLC) to hold various components of the investment.
1. First, create a magic black
box called Royalty Company, LLC, owned equally by Owner and Partner;
2. Transfer the venture's intellectual
property (tradename, trade dress, other intangibles) to Royalty Company;
and
3. Have Owner's 50% interest in Royalty Company
transferred to Owner's family members (or trusts for family members),
but managed and controlled by the Owner (a relationship known as a
"manager managed" LLC) and Foreign Partner.
a. Royalty Company licenses the intellectual property
to venture. Venture pays tax-deductible royalties back to Royalty
Company, thereby reducing the taxable income in the venture payable
to the foreign country.
1) Of course, this general
concept will need to be adjusted depending on the tax laws of the
foreign country.
C. The Result: Owner has just created a structure
that achieves both tax planning and asset protection
1. A stream of income flowing
out of the venture (in most cases avoiding income taxes in the foreign
country) and into Royalty Company which is owned directly by Owner's
family members or trusts.
2. Most importantly, one can achieve
significant asset protection: Assets in Royalty Company are separated
from potential lawsuits and claims by venture's creditors (including
tax collectors).
D. OCC Plan™ uses an analysis of which assets to transfer similar
to that of analyzing a franchise.
1. Which assets would the franchisor
hold and which would the operating company retain?
a. Example: McDonald's - they
lease the land, license the name, sell the cups and materials.
2. Identifying the intangibles
for a business requires an analysis of the particular business. There
is no cookie-cutter approach to creating OCC Plan™ .
E. Royalty Company then licenses back the intellectual
property to Operating Company at an arm's-length, fair market value
royalty rates
1. The licensing agreement needs
to be documented and must be reasonable in amount.
F. Potential tax consequences upon the intellectual
property transfer
1. Transferring the intellectual
property to Royalty Company may require a sale, either by Operating
Company or the Owner.
2. Usually, the sale will generate
capital gains to the seller, taxed in the U.S. at the long-term capital
gains rate of 15% (assuming the assets are U.S.-based).
3. The sale may be on an installment
basis (over a set number of years), so that Royalty Company uses the
income generated from the royalty agreement to pay for the sale.
4. Result: With a sale of intellectual
property to Royalty Company, there is a conversion from ordinary income
(taxed at a maximum rate of 35% federal) to capital gains (taxed at
15% federal).
G. Non-tax business purposes for the structure
1. With the intellectual property
isolated in a separate entity, the intellectual property can then be
licensed to newly-formed operating companies as part of an expansion
program.
a. The original Operating Company
and any newly-formed company may give ownership interests to key employees
and managers (such as employee stock options or similar incentive
programs).
b. The Royalty Company follows
a franchising model, which means that expansion through non-family
owners or franchising is possible.
2. Funding and investment opportunities
multiply because investors can be limited to a particular store or operation,
without gaining a claim on the Royalty Company's intellectual property.
3. OCC Plan™ can be used
to accomplish family and estate planning by providing various family
members with interests in several entities.
H. Royal Company's after-tax income
1. Channel earnings from high-tax venture to a black-box
entity located in a taxing jurisdiction with low (or no) tax brackets.
a. The structure and ownership
of the black-box entity will determine how income is taxed. In the
U.S., children over age 14 are taxed at their individual rates. 10%
for first $7,000 earned; 15% for the next $22,000 - effectively $29,000
is taxed at lower brackets.
b. As always, the devil is in
the details and these transactions must be properly structured and
documented. Remember, IRS and other tax authorities' favorite line
of attack is lack of business purpose, paperwork and follow-through.
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