By Robert B. Milligan, Paul E. Freehling , Seyfarth Shaw LLP
Continuing our tradition of presenting annually our thoughts concerning the top 10 developments/headlines this past year in trade secret, computer fraud, and non-compete law, here—in no particular order—is our listing for 2015 and a few predictions for 2016.
1) Enactment of federal trade secret legislation moves closer, while federal non-compete bill gains no traction. In last year’s Top 10 listing, and in several blog posts from 2015, we described the ongoing effort of a large bipartisan group of U.S. Senators and Representatives to create a federal civil cause of action for trade secret misappropriation (according to govtrack.us, as of January 11, 2016 there were 23 cosponsors of such legislation in the Senate and 107 in the House). The proposed bill is entitled “The Defend Trade Secrets Act of 2015” (“DTSA”). On December 2, 2015, the Senate Judiciary Committee held a hearing on the DTSA and it received a positive reaction from the Committee. We expect that the DTSA will be voted on by Congress in the spring of 2016.
Many industry representatives who have written or spoken on the subject support the DTSA. They cite such reasons as: (a) it will provide uniform statutory provisions in contrast to the “Uniform Trade Secrets Act” (“UTSA”)—adopted by every state except New York and Massachusetts—but which contains some significant state variations; (b) rather than litigate in state courts, some attorneys and companies prefer federal courts, particularly because of federal bench experience with patent, trademark, and copyright cases; (c) personal jurisdiction over defendants may be easier to obtain in a federal court than in a state court with respect to individuals or businesses charged with claims involving overseas trade secret misappropriation or computer fraud and discovery of parties and non-parties may be easier to conduct in federal court; and (d) the statute of limitations in the proposed DTSA is longer, and the maximum amount that can be awarded as punitive damages is higher than the amount available under the UTSA.
A number of academics oppose adoption of the DTSA. They suggest that the expense of litigating in federal court often exceeds the cost of handling a case in a state court. Some also take issue with, among other sections, the ex parte seizure provisions in the DTSA (although proponents cite those provisions as advantages). Opponents of the DTSA mention that the UTSA has had years of judicial interpretation that provides some measure of predictability. Opponents have also voiced concern with respect to some potentially ambiguous terms in the proposed DTSA.
We also reported on proposed federal legislation to ban enforcement of non-competes against low wage employees and to require employers to disclose in advance that employees must sign non-competes. The Senate bill is called “Mobility and Opportunity for Vulnerable Employees” (“MOVE”). At present, MOVE has few sponsors and does not appear to be gaining any traction.
Please see our dedicated page for the latest updates on the proposed federal trade secret legislation. As discussed below, we expect regulators and employees to continue to challenge the necessity and breadth and scope of non-compete agreements in certain industries.
2) Watch for challenges to (a) confidentiality covenants interpreted as discouraging cooperation with government agency investigations or chilling Section 7 rights and (b) “do-not-hire” agreements. In 2015, federal government agencies such as the SEC took aim at confidentiality clauses seemingly intended to dissuade employees from whistleblowing with respect to alleged employer misconduct. Additionally, the NLRB continued its crusade of striking employer confidentiality agreements/policies that may chill employees from exercising their rights under the National Labor Relations Act. Accordingly, we expect that non-disclosure provisions that interfere with government investigations or chill Section 7 rights will continue to be scrutinized in 2016. Further, the government previously challenged agreements among competitors that prohibited them from hiring their competitors’ employees. Plaintiffs’ attorneys have attempted to capitalize on such efforts by bringing class actions for alleged unlawful “do-not-hire” arrangements between competitors and some cases have resulted in large settlements. We expect to see more such cases in 2016.
3) The Ninth Circuit’s narrow interpretation of the Computer Fraud and Abuse Act (“CFAA”) was supported by some courts in other circuits, but rejected by others, and other computer hacking issues continue to percolate. The CFAA states that one who “intentionally accesses a computer without authorization or exceeds authorized access” commits a crime. 18 U.S.C. § 1030. In 2012, in U.S. v. Nosal, the Ninth Circuit Court of Appeals (in a divided en banc decision) adopted the narrow interpretation that the only intended targets of the law were hackers who “break into” a computer and that the statute does not criminalize the unauthorized use of computerized data by misguided employees. 676 F.2d 854. The same court reiterated that view in U.S. v. Christensen, Nos. 08-50531, et al. (Aug. 28, 2015). The court added, however, that California Penal Code § 502, which prohibits unauthorized taking or using information on a computer without permission, does not require unauthorized access and, therefore, is markedly unlike 18 U.S.C. § 1030.
In decisions announced before 2015, the Fourth Circuit concurred with Nosal, but the First, Fifth, Seventh, and Eleventh disagreed. Judicial decisions in 2015 supported each position and, therefore, further muddied the waters.
In U.S. v. Valle, Nos. 14-2710-cr and 14-4396-cr (2d Cir., Dec. 3, 2015) (2-1 decision), the majority concluded that there is equal merit to the narrow statutory interpretation announced in Nosal, and the diametrically opposed, broader interpretation set forth by courts disagreeing with Nosal. Based solely on the doctrine of lenity, the Second Circuit adopted the narrow view.
Two judges in the Middle District of Florida reached opposite conclusions regarding Cf. Nosal (Allied Portables v. Youmans, 2015 WL 6813669 (June 15, 2015) (following Nosal), with Enhanced Recovery Co. v. Frady, No. 13-cv-1262-J-34JBT (Mar. 31, 2015) (rejecting Nosal)). A federal court in Utah adopted the broader interpretation in 2015. Giles Construction, LLC v. Tooele Inventory Solution, Inc., No. 12-cv-37 (June 2, 2015). A judge in the Western District of Michigan followed Nosal. Experian Marketing Solutions, Inc. v. Lehman, No. 15-cv-476 (W.D. Mich., Sept. 25, 2015). A judge in the Eastern District of Michigan wrote a lengthy criticism of Nosal, and a prediction that the Sixth Circuit would not follow the Ninth, but the judge ultimately decided that the complaint before him stated a cause of action regardless of which statutory interpretation was intended. American Furukawa, Inc. v. Hossain, No. 14-cv-13633 (May 6, 2015). These widely disparate rulings will leave many employers without a clear path to follow.
Moreover, one Assistant U.S. Attorney told Congress in 2015 that the CFAA should be amended to clarify which of the two conflicting views Congress intended. We predict that, unless the statute is amended, the U.S. Supreme Court will have to resolve the circuit court split.
Additionally, we expect that the Ninth Circuit will issue another decision in the U.S. v. Nosal case this year to address whether password sharing to obtain access to a protected computer is actionable under the CFAA. Additionally, we expect to see more Penal Code section 502 claims in California based upon the alleged misuse of company information “without permission.”
4) Security breaches continue to plague owners of confidential data. Hackers, nation states, competitors, and disgruntled employees are among those responsible for the breach and dissemination of confidential data. Following the Ashley Madison incident and some other highly publicized incidents, we expect to see more data breaches and resulting litigation in 2016, particularly in those jurisdictions where courts have been willing to soften the standing requirements for maintaining such suits. To guard against this risk, it is essential that companies have comprehensive information security policies and solid data breach response plans in place.
Sometimes the breach benefits only a single individual or entity, such as when an employee transfers employers and provides proprietary information belonging to the former employer to the new employer. However, the more serious consequences occur when, without the owner’s authorization, such data is published on-line for all the world to see. To make matters worse, social media privacy legislation and other privacy laws can often frustrate efforts to identify the thief and to abort the publication.
In connection with a recent New York Supreme Court—New York’s trial court—injunction hearing, a party accidentally filed its trade secrets on the New York State Courts Electronic Filing system. The adversary insisted, over the vehement objection of the party that made the inadvertent filing, that this act constituted a posting on the Internet that rendered the information publicly available. The court has delayed making a definitive ruling. On the other coast, the Northern District of California recognized that the issue occurring in New York could arise in California. The court, proactively, promulgated guidelines on its website for the prompt and effective removal of erroneous e-filings.
5) Employers’ attempts to enforce non-compete and non-solicitation covenants against lower level employees troubles courts and legislators. At one time, courts normally appeared sympathetic to the principle espoused by employers that parties’ non-competition and non-solicitation covenants were contracts that should be enforced. In 2015, although some courts enforced restrictive covenants, a number of judges refused to grant preliminary injunctions sought by former employers against ex-employees. See, e.g., Great Lakes Home Health Services Inc. v. Crissman, No. 15-cv-11053 (E.D. Mich., Nov. 2, 2015); Evans v. Generic Solutions Engineering, No. 5D15-578 (Fla. App., Oct. 30, 2015); Burleigh v. Center Point Contractors, 2015 Ark. App. 615 (Oct. 28, 2015). Each of these courts concluded that the employers had not demonstrated the requisite extreme need for injunctive relief and protection. We expect courts to continue to make it difficult on employers to obtain injunctive relief in 2016, particularly where the employee is lower level and there is no clear evidence of imminent harm. We also saw some efforts (though not successful) in Michigan, Washington, Iowa, and Massachusetts to ban or otherwise limit non-competes.
6) Enforcement of restrictive covenants against franchisees gains traction. The NLRB signaled in 2015 its view that a franchisor’s control over the business practices of franchisees may lead to treating the franchisor as a joint employer of the franchisees’ employees. Additionally, some courts held in 2015 that restrictive covenants in a franchise agreement could be enforced by the franchisor against both the franchisees and persons who benefit from but are not signatories to the franchise agreement.
Some franchisors have sued to enforce covenants in contracts with franchisees. An Ohio federal judge in 2015 ordered an ex-franchisee that had signed a confidentiality agreement to return to the franchisor its operations manual, brochures, contracts, correspondence, client files, computer database, and other records relating to the franchise agreement. H.H. Franchising Sys., Inc. v. Aronson, No. 12-cv-708 (Jan. 28, 2015). Additionally, a Wisconsin judge held that an individual who was not a signatory to a franchise agreement that included a confidentiality clause, but who had benefitted from the franchise, was prohibited from using the franchisor’s trade secrets. Everett v. Paul Davis Restoration, Inc., No. 10-C-634 (E.D. Wis., Apr. 20, 2015). We expect to see more litigation involving franchisees and related parties in 2016.
7) Courts struggle with issues relating to the adequacy of consideration for restrictive covenants. The controversial Fifield decision by the Illinois Appellate Court several years ago continued to make waves in 2015. The court in Fifield held that a restrictive covenant executed by an at-will employee is unenforceable, for lack of adequate consideration, unless the employment relationship lasts at least two years beyond the date of execution. Fifield v. Premier Dealer Service, 993 N.E.2d 938 (Il. App (1st) 2013). The Illinois Supreme Court has not yet opined on that holding. This past year, several Chicago federal trial judges, adjudicating cases in which they decided it was necessary to predict whether the Illinois Supreme Court would agree with Fifield, reached opposing conclusions. Moreover, in McInnis v. OAG Motorcycle Ventures, Inc., 35 N.E.3d 1076 (Il. App. (1st) 2015), a panel of the Illinois Appellate Court split 2-1 on the question of whether Fifield should be followed.
Another wrinkle involving consideration arose in Pennsylvania, which adopted the so-called “Uniform Written Obligations Act” (“UWOA”) (solely in force in Pennsylvania). Under the UWOA, if a written contract contains a commitment to which the parties “intend to be legally bound,” then the parties may not question the adequacy of consideration for the agreement. On the other hand, the state has a long history of disfavoring restrictive covenants in employment agreements. This past year, the Pennsylvania Supreme Court ruled unenforceable for lack of consideration a covenant entered into after the commencement of employment, but for which no benefit or favorable change in employment status was given to the employee. Socko v. Mid-Atlantic Systems of CPA, Inc., Case No. 3-40-2015 (Nov. 18, 2015). This ruling came down notwithstanding the UWOA, even though the agreement expressly quoted the “legally bound” language of that law. See id. This decision does not alter the doctrine that covenants signed by employees upon hire are supported by adequate consideration. We expect to see more challenges to the adequacy of consideration by employees in 2016.
8) New state legislation concerning restrictive covenants. State legislatures have enacted, and probably will continue to enact, new laws bearing on restrictive covenants.
- New Hawaii statute. Passed in 2015, it provides that a non-compete or non-solicit clause in an employment contract for an employee of a technology business is void.
- New Connecticut, Montana, and Virginia statutes. In 2015, these three states joined more than a dozen others by enacting laws that restrict employer access to personal social media accounts of employees and job applicants. We predict that these laws will adversely impact employers’ efforts to uncover trade secret theft.
- New Mexico health care practitioner statute. A law passed in 2015 provides that an employer of a health care practitioner may not enforce a non-compete covenant restricting the practitioner from providing post-termination clinical health care services.
- Alabama and Oregon statutes. Alabama revised its non-compete statute (effective January 1, 2016). The revised statute will make it easier for employers to enforce non-competes against Alabama employees. Additionally, Oregon limited the duration of non-competes with employees to 18 months. The new law is also effective January 1, 2016.
9) Rulings regarding validity of forum selection provisions in restrictive covenant agreements. Some multi-state employers use one-size-fits-all covenants, and that practice—coupled with a litigant’s forum shopping—sometimes leads to unexpected inconsistencies. California’s policy, articulated in Business and Professions Code Section 16600 (which provides that employee non-compete clauses are typically void), has figured in a number of these cases and likely will continue to do so. California courts continue to dismiss or transfer such cases to other states in accordance with contracting parties’ forum choice notwithstanding employees’ arguments that the forum state might enforce covenants which seemingly are void in California. We did see some reluctance by courts in Delaware and New York to impose broad restrictive covenants on employees in 2015, particularly where the designated choice of law may unfairly impact the employee.
10) Proposed EU Directive to protect trade secrets makes progress; vote nears on U.S. involvement in Trans Pacific Partnership. The European Union and other foreign countries have varying rules with regard to the protection of trade secrets. In some instances, there are no rules regarding trade secret protection or the laws are not enforced. A U.S. company doing business abroad may encounter a wide variety of practices applicable to trade secrets. There has been an effort to harmonize trade secrets law abroad to provide minimum standards as exemplified by the EU Directive.
As we reported, the proposed EU Directive crossed yet one more procedural hurdle with a provisional agreement on the Directive reached by the European Council (represented by the Luxembourg presidency) and representatives of the European Parliament. Now that the provisional agreement has been reached, the Parliament and Council will conduct a legal-linguistic review of the text. Once that process has been completed, the proposed Directive will then be submitted to the full Parliament for approval. Currently, the Parliament is expected to vote on the Directive around March 2016, but the precise date for a first reading has yet to be determined.
Additionally, as we reported, a proposed trade agreement, the Trans Pacific Partnership, was reached in October 2015 among a dozen Pacific Rim countries and the U.S. While the implementing legislation still needs to be passed by the signatory countries, the agreement will require signatory nations, such as Australia, Canada, Singapore, and Malaysia, to implement criminal procedures and penalties for the unauthorized misappropriation of trade secrets. The agreement signifies the Obama Administration’s continued effort to enhance trade secret protections at home and abroad for the benefit of U.S. companies.
Lockdown 2.0 – Here’s how to be the best-looking person in the virtual room
suggests “the product you’re creating is not the camera, the lens or a webcam’s clever industrial design. It’s the subject, you, which is just on e part of the entire image they see. You want that image to convey quality, not convenience.”
Technology experts at Reincubate saw an opportunity in the rise of remote-working video calls and developed the app, Camo, to improve the video quality of our webcam calls. As part of this, they consulted the digital photography expert and author, Jeff Carlson, to reveal how we can look our best online.
It’s clear by now that COVID-19 has normalised remote working, but as part of this the importance of video calls has risen exponentially. While we’re all used to seeing the more casual sides of our colleagues (t-shirt and shorts, anyone?), poor webcam quality is slightly less forgivable.
But how can we improve how we look on video? We consulted Jeff Carlson for some top tips– here is what he had to say.
- Improve the picture quality of your call
The better your camera, the higher quality your webcam calls will be. Most webcams (as well as currently being hard to get hold of and expensive), are subpar. A DSLR setup will give you the best picture, but will cost $1,500+. You can also use your iPhone’s amazing camera as a webcam, using the new app from Reincubate, Camo.
Jeff’s comments “The iPhone’s camera system features dedicated coprocessors for evaluating and adjusting the image in real time. Apple has put a tremendous amount of work into its imaging software as a way to compensate for the necessarily small camera sensors. Although it all works in service of creating stills and video, you get the same benefits when using the iPhone as a webcam.”
Aidan Fitzpatrick, CEO of Reincubate explains why the team created Camo, “Earlier this year our team moved to working remotely, and in video calls everyone looked pretty bad, irrespective of whether they were on built-in Mac webcams or third-party ones. Thus began my journey to build Camo: an iPhone has one of the world’s best cameras in it, so could we make it work as a webcam? Category-leading webcams are noticeably worse than an iPhone 7. This makes sense: six weeks of Apple’s R&D spend tops Logitech’s annual gross revenue.”
- Place your camera at eye level
A video call will never quite be the same as a face-to-face conversation, but bringing your camera up to eye level is a good place to start. That can involve putting your laptop on a stand or pile of books, mounting a webcam to the top of your display screen, or even using a tripod to get the perfect position.
Jeff points out, “If the camera is looking down on you, you’ll appear minimized in the frame; if it’s looking up, you’re inviting people to focus on your chin, neck, or nostrils. Most important, positioning the camera off your eye level is a distraction. Look them in the eye, even if they’re miles or continents away.”
Low camera placement from a MacBook
- Make the most of natural lighting
Be aware of the lighting in the room and move yourself to face natural lighting if you can. Positioning the camera so any natural light is behind you takes the light away from your face, which can make it harder to see and read expressions on a call.
Jeff Carlson’s top tip: “If the light from outside is too harsh, diffuse it and create softer shadows by tacking up a white sheet or a stand-alone diffuser over the window.”
Backlit against a window Facing natural light
- Use supplementary lighting like ring lights
The downside to natural lighting is that you’re at the mercy of the elements: if it’s too bright you’ll have the sun in your eyes, if it’s too dark you won’t be well lit.
Jeff recommends adding supplementary lighting if you’re looking to really enhance your video calls. After all, it looks like remote working will be carrying on for quite some time.
“The light can be just as easy as a household or inexpensive work light. Angle the light so it’s bouncing off a wall or the ceiling, depending on your work area, which, again, diffuses the light and makes it more flattering.
Or, for a little money, use a softbox or a shoot-through umbrella with daylight bulbs (5500K temperature), or if space is tight, LED panels. Larger lights are better for distributing illumination– don’t be afraid to get them in close to you. Placement depends on the look you’re going after; start by positioning one at a 45-degree angle in front and to the side of you, which lights most of your face while retaining nice shadow detail.”
In some cases, a ring light may work best. LEDs are arranged in a circle, with space in the middle to put the camera’s lens and get direct illumination from the direction of the camera.
- Centre yourself in the frame
Make sure you’re getting the right angle and that you’re using the frame effectively.
“You should aim for people to see your head and part of your torso, not all the space between your hair and the ceiling. Leave a little space above your head so it’s not cut off, but not enough that someone’s eyes are going to drift there.”
- Be mindful of your backdrop
It’s not always easy to get the quiet space needed for video calls when working from home, but try as best you can to remove anything too distracting from your background.
“Get rid of clutter or anything that’s distracting or unprofessional, because you can bet that will be the second thing the viewers notice after they see you. (The Twitter account @RateMySkypeRoom is an amusing ongoing commentary on the environments people on television are connecting from.)”
A busy background as seen by a webcam
- Make the most of virtual backgrounds
If you’re really struggling with finding a background that looks professional, try using a virtual background.
Jeff suggests: “Some apps can identify your presence in the scene and create a live mask that enables you to use an entirely different image to cover the background. While it’s a fun feature, the quality of the masking is still rudimentary, even with a green screen background that makes this sort of keying more accurate.”
- Be aware of your audio settings
Our laptop webcams, cameras, and mobile phones all include microphones, but if it’s at all possible, use a separate microphone instead.
“That can be an inexpensive lavalier mic, a USB microphone, or a set of iPhone earbuds. You can also get wireless lavalier models if you’re moving around during a call, such as presenting at a whiteboard in the camera’s field of view.
The idea is to get the microphone closer to your mouth so it’s recording what you say, not other sounds or echoes in the room. If you type during meetings, mount the mic on an arm instead of resting it on the same surface as your keyboard.”
- Be wary of video app add-ons
Video apps like Zoom include a ‘Touch up your appearance’ option in the Video settings. This applies a skin-smoothing filter to your face, but more often than not, the end result looks artificially blurry instead of smooth.
“Zoom also includes settings for suppressing persistent and intermittent background noise, and echo cancellation. They’re all set to Auto by default, but you can choose how aggressive or not the feature is.”
- Be the best looking person in the virtual room
What’s important to remember about video calls at this point in time is that most people are new to what is, really, personal broadcasting. That means you can easily get an edge, just by adopting a few suggestions in this article. When your video and audio quality improves, people will take notice.
Bringing finance into the 21st Century – How COVID and collaboration are catalysing digital transformation
By Keith Phillips, CEO of TISATech
If just six or seven months ago someone had told you that in a matter of weeks people around the world would be locked down in their homes, trying to navigate modern work systems from a prehistoric laptop, bickering with family over who’s hogging the Wi-Fi, migrating online to manage all financial services digitally, all while washing their hands every five minutes in fear of a global pandemic… You’d think they had lost their mind. But this very quickly became the reality for huge swathes of the world and we’re about to go through that all over again as the UK government has asked that those who can work from home should.
Unsurprisingly, statistics show that lockdown restrictions introduced by the UK government in March, led to a sharp increase in people adopting digital services. Banks encouraged its customers to log onto online banking, as they limited (and eventually halted) services at branches. This forced many customers online as their primary means of managing personal finances for the first time.
If anyone had doubts before, the Covid-19 pandemic proved to us the importance of well-functioning, effective digital financial services platforms, for both financial institutions and the people using them.
But with this sudden mass online migration, it’s become clear that traditional banks have struggled to keep up with servicing clients virtually. Legacy banking systems have always stilted the digitisation of financial services, but the pandemic thrust this issue into the limelight. Fintech firms, which focus intently on digital and mobile services, knew it was only a matter of time before financial institutions’ reliance was to increase at an unprecedented rate.
For years, fintechs have been called upon by traditional players to find solutions to problems borne from those clunky legacy systems, like manual completion of account changes and money transfers. Now it is the demand for these services to be online coupled with the need for financial services firms to cut costs, since Covid-19 hit the economy.
Covid-19 has catalysed the urgent need to bring digital transformation to a wider pool of financial services businesses. Customers now have even higher expectations of larger institutions, demanding that they keep up with what the younger and more nimble challengers have to offer. Industry leaders realise that they must transform their businesses as soon as possible, by streamlining and digitising operations to compete and, ultimately, improve services for their customers.
The race for digital acceleration began far before the recent pandemic – in fact, following the 2008 financial crisis is likely more accurate. Since the credit crunch, there has been a wave of new fintech firms, full of young, bright techies looking to be the next big thing. Fintechs have marketed themselves hard at big conferences and expos or by hosting ‘hackathons’, trying to prove themselves as the fastest, most innovative or the most vital to the future of the industry.
However, even during this period where accelerating innovation in online financial services and legacy systems is crucial, the conditions brought about by the pandemic have not been conducive to this much-needed transformation.
The second issue, which again was clear far before the pandemic, is that fact that no matter how nimble or clever the fintechs’ solutions are, it is still hard to implement the solutions seamlessly, as the sector is highly fragmented with banks using extremely outdated systems populated with vast amounts of data.
With the significance of the pandemic becoming more and more clear, and the need for better digital products and services becoming more crucial to financial services firms and consumers by the day, the industry has finally come together to provide a solution.
The TISAtech project was launched last month by The Investing and Saving Alliance (TISA), a membership organisation in the UK with more than 200 leading financial institutions as members. TISA asked The Disruption House, a specialist benchmarking and data analytics business, to create a clearing house platform for the industry to help it more effectively integrate new financial technology. The project aims to enhance products and services while reducing friction and ultimately lowering costs which are passed on to the customers.
With nearly 4,000 fintechs from around the world participating, it will be the world’s largest marketplace dedicated to Open Finance, Savings, and Investment.
Not only will it provide a ‘matchmaking’ service between financial institutions an fintechs, it will also host a sandbox environment. Financial institutions can pose real problems with real data and the fintechs are given the space to race to the bottom – to find the most constructive, cost-effective solution.
Yes, there are other marketplaces, but they all seem to struggle to achieve a return on investment. There is a genuine need for the ‘Trivago’ of financial technology – a one stop shop, run by an independent body, which can do more than just matchmaking. It needs to go above and beyond to encompass the sandboxing, assessments, profiling of fintechs to separate the wheat from the chaff, and provide a space for true collaboration.
The pandemic has taught us that we are more effective if we work together. We need mass support and collaboration to find solutions to problems. Businesses and industries are no different. If fintechs and financial institutions can work together, there is a real chance that we can start to lessen the economic hit for many businesses and consumers by lowering costs and streamlining better services and products. And even if it is just making it that little bit easier to manage personal finances from home when fighting with your children for the Wi-Fi, we are making a difference.
What to Know Before You Expand Across Borders
By Sean King, Director of International Tax at McGuire Sponsel
The American retail giant, Target Corporation, has a market cap of $64 billion and access to seemingly limitless resources and advisors. So, when the company engaged in its first global expansion, how could anything possibly go wrong?
Less than two years after opening its first Canadian store in 2013, Target shut down all133 Canadian locations and terminated more than 17,000 Canadian employees.
Expansion of an operation to another country can create unique challenges that may impact the financial viability of the entire enterprise. If Target Corporation can colossally fail in its expansion to Canada, how might Mom ‘N’ Pop LLC fare when expanding into Switzerland, Singapore, or Australia?
Successful global expansion requires an understanding of multilayered taxes, regulatory hurdles, employment laws, and cultural nuances. Fortunately, with the right guidance, global expansion can be both possible and profitable for businesses of any size.
Any company with global ambitions must first consider whether the company’s expansion outside of the U.S. will give rise to a taxable presence in the local country. In the cross-border context, a “permanent establishment” can be created in a local country when the enterprise reaches a certain level of activity, which is problematic because it exposes the U.S. multinational to taxation in the foreign country.
Foreign entity incorporation
To avoid permanent establishment risk, many U.S. multinationals choose to operate overseas through a formal corporate subsidiary, which reduces the company’s foreign income tax exposure, though it may result in an additional level of foreign income tax on the subsidiary’s earnings. In most jurisdictions, multinationals can operate their business in the foreign country as a branch, a pass through (e.g., partnership,) or a corporation.
As a branch, the U.S. multinational does not create a subsidiary in the foreign country. It holds assets, employees, and bank accounts under its own name. With a pass through, the U.S. multinational creates a separate entity in the foreign country that is treated as a partnership under the tax law of the foreign country but not necessarily as a partnership under U.S. tax law.
U.S. multinationals can also create corporate subsidiaries in the foreign country treated as corporations under the tax law of both the foreign country and the U.S., with possibly two levels of income taxation in the foreign country plus U.S. income taxation of earnings repatriated to the U.S. as dividends.
Under U.S. entity classification rules, certain types of entities can “check the box” to elect their classification to be taxed as a corporation with two levels of tax, a partnership with pass-through taxation, or even be disregarded for U.S. federal income tax purposes. The check the box election allows U.S. multinationals to engage in more effective global tax planning.
Toll charges, transfer pricing and treaties
When establishing a foreign corporate subsidiary, the U.S. multinational will likely need to transfer certain assets to the new entity to make it fully operational. However, in many cases, the U.S. multinational cannot perform the transfer without recognizing taxable income. In the international context, the IRS imposes certain outbound “toll charges” on the transfer of appreciated property to a foreign entity, which are usually provided for in IRC Section 367 and subject to various exceptions and nuances.
Instead, the U.S. multinational may prefer to license intellectual property to the foreign subsidiary for a fee rather than transfer the property outright. However, licensing requires the company and foreign subsidiary to adhere to transfer pricing rules, as dictated by IRC Section 482. The U.S. multinational and the foreign subsidiary must interact in an arms-length manner regarding pricing and economic terms. Furthermore, any such arrangement may attract withholding taxes when royalties are paid across a border.
Are you GILTI?
Certain U.S. multinationals opt to focus on deferring the income recognition at the U.S. level. In doing so, they simply leave overseas profits overseas and delay repatriating any of the earnings to the U.S.
Despite the general merits of this form of planning, U.S. multinationals will be subject to certain IRS anti-deferral mechanisms, commonly known as “Subpart F” and GILTI. Essentially, U.S. shareholders of certain foreign corporations are forced to recognize their pro rata share of certain types of income generated by these foreign entities at the time the income is earned instead of waiting until the foreign entity formally repatriates the income to the U.S.
The end goal
Essentially, all effective international tax planning boils down to treasury management. Effective and early tax planning can properly allow a company to better achieve its initial goal: profitability.
If global expansion is on the horizon for your company, consult a licensed professional for advice concerning your specific situation.
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Lockdown 2.0 – Here’s how to be the best-looking person in the virtual room
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Banks take note: Customers want to pay with points
By Len Covello, Chief Technology Officer of Engage People ‘Pay with Points’ – that is, integrating the ability to pay...
Are you a fighter or a freezer? The 4 “F’s” of Surviving Danger
By Dr.Roger Firestien, Author of Create In a Flash. The fight, flight, freeze survival response – or FFF for short...
Why the FemTech sector might be the sustainability saviour we have been waiting for
By Kristy Chong, CEO & Founder Modibodi ® Taking single use plastics out of circulation is no easy feat, but...