Foreign Persons: Nonbusiness
U.S. Source Income - Ch. 4
Code §871(a) & §881(a) – concerning imposition of the
30% gross tax on fixed or determinable annual or periodic income (FDAP).
But, FDAP can be “effectively connected” with a U.S. trade
or business and, then, be taxed on a net income basis. §864(c)(2).
Possible modification of the applicable (gross withholding)
tax rates by (1) a Code § or (2) a bilateral U.S. income tax treaty provision.
Why impose tax on a gross
basis? p.209
Flat tax on a gross income facilitates collection at source
(through withholding) without a taxpayer filing an income tax return.
Limited potential to collect tax in a foreign place.
Gross income and net income are approximately the same
amount in many situations involving investment income (i.e., no significant
expenses are incurred to generate the investment income).
Is 30% the appropriate tax rate? Cf., the corporate
tax rate of 35% on “net income” or 39.6% top bracket for individual
taxation.
What is “FDAP Income”?
p.230
Interest, dividends, rents and royalties and other fixed or
determinable annual or periodic “gains, profits and income.” Code
§871(a)(1)(A) & §881(a)(1).
Consider other income sources: annuities, retirement plan
distributions, alimony.
Is a recovery of (any) tax basis permitted in
determining the gross amount subject to this withholding at source?
Wodehouse case
p.231
One Payment Disposition
Lump sum amount was received for an exclusive book right in
the United States.
Sale of the property interest in a copyright.
Held: one lump sum amount (not contingent)
represented the acceleration of all the royalties and, therefore, FDAP.
Do not need multiple payments to have "annual or
periodic" payments.
Is this case correctly decided?
FDAP Income
Additional Examples p.232
1) Rental income gross-up for expenses or real estate
taxes paid by tenant – Rev. Rul. 73-522
2) Annuity payments from a U.S. insurer. Rev. Rul.
2004-75 (p. 232). Treated as having a U.S. source even though sold by a
foreign branch in a foreign country. Cf., branch bank sourcing rules.
3) §871(m) – “dividend equivalent
payments” – (e.g., sale of corp. pre-dividend distribution) treated as
dividends for tax withholding at source purposes.
Chihuahua
Gas p.234
§881(a) as Basis for Decision
Rent not paid by a Mexican corporation (HIDRO) ETBUS to a
related Mexican corporation (Gas) for U.S. use of Gas trucks.
Tax liability results from a Code §482 adjustment. No
payments had been made from which the tax could be withheld. Tax obligation of
the recipient of the imputed rent exists under §881.
Must an actual payment be made to trigger (1)
§881(a) liability (no), & (2) withholding at source??
Treatment of OID
p.238
Consider original issue discount (OID) which is accruing on
a financial instrument held by a foreign party.
Is this the economic equivalent of interest, but not
actually paid, rather accrued?
What treatment when OID to a foreign party is not ECI USTB?
The 30% withholding tax is applicable when (1) obligation
is paid, or (2) obligation is sold.
But, the OID may be tax-exempt and withholding is then not
relevant.
U.S. Source Interest &
Tax Exemptions p.238
1) Bank (& S&L) account interest paid:
Code §§871(i)(2)(A) & 881(d) – exemption.
2) “Portfolio debt” investment interest:
Code §§871(h) & 881(c) – exemption.
“Bearer” form permitted for financial instrument? But,
registered form required in 2012 & after.
No statutory exemption for (1) 10%+ owners or (2)
contingent interest.
What is the impact of these exemption provisions on the
U.S. capital markets?
Interest from a U.S. 80-20
Corporation p.240
Interest paid by U.S. corp. is domestic source.
But, interest paid by a U.S. corporation was previously
foreign source if more than 80% of U.S. corp. income was from foreign source
(i.e., an 80-20 corporation).
See prior §861(a)(1)(A) and §861(c).
2010 legislation: this interest is now treated as U.S.
source (subject to various grandfathering rules).
Dividends from a U.S.
Corporation p.240
1) Dividends from a U.S. corporation. Code
§861(a)(2)(A) – U.S. sourced
2) Prior rule: U.S. corp. and 80%+ foreign
source dividend income: Code §871(i)(2)(B) – untaxed proportion based on the
foreign percentage. Eliminated in 2010 (Hire Act) & now U.S. sourcing
& withholding. Cf., interest rule: a sourcing rule.
3) Foreign corp. with U.S. source dividends.
The branch profits tax rule eliminates the tax
liability on a dividend distribution.
Wagering Income p.241
1) Las Vegas gambling - Code §871(j)
2) Horse & dog racing - Code §872(b)(5)
3) Lottery winnings?
How prove net gambling winnings?
Any offset for invested funds/tax basis?
Any offset for gambling losses? Note §861(a)
& 165(d) – losses
allowed to extent of gains.
Any withholding at source imposed on foreign parties?
Domestic parties? 1099s?
See Anti-injunction Act & §7421(a), p. 242.
Impact of Income Tax Treaty
Provisions p.242
Tax treaty reduction – impact on withholding rates:
Dividends (Art. 10): 15%; but, 5% for certain corps.
(note recent U.S. treaties – zero withholding tax for payments from
subsidiaries)
Interest (Art. 11): -0-
Royalties (Art. 12): -0- (cross-licensing – next slide)
Pensions, annuities & alimony (Art. 17): -0-
Annuity defined – see Abeid case, p.243;
gambling income is not an annuity (with basis).
Child support not included - not gross income.
Royalty Withholding &
Cross Licensing
Rev. Proc. 2007-23 - cross-licensing – two parties grant
licenses to each other.
Withholding obligation on gross value? Net?
Rev. Proc. states: (1) No §1001 gain (or loss) when mutual grants of
licenses;
(2) “Net consideration” to be taken into
account for (withholding) tax purposes – assuming a “qualified patent cross
licensing arrangement” (QPCLA).
(3) Financial statement conformity (i.e.,
“booking”) requirement.
“Treaty Shopping” – Funds
Inbound into the U.S. p.244
Historical background: (1) Netherlands Antilles finance
sub created by (2) U.S. Corp. (or by foreign corp.).
Purpose: to facilitate borrowing arrangements through the
Antilles and utilize the U.S. income tax treaty exemption on interest expense
paid outbound from U.S. Corp. to the N.A. lender affiliate (who borrowed from
outside U.S.).
This income tax treaty thereby functioned as a “treaty with
the world.” Why & how?
Aiken Industries
p.245 Conduit Arrangement
ECL-Bahamas
Aiken-US (parent) CCN-Ecuador (parent)
MPI - US (sub)
Industrias-Honduras (sub)
1) MPI borrows from ECL.
2) ECL sells MPI note to Industrias (in exchange for
Industrias notes payable to ECL).
3) MPI then pays interest expense to Industrias.
4) Honduras-U.S. (former) income tax treaty exempts
interest paid from source taxation.
Valid business purpose for this transaction? No.
Industrias merely a conduit to ECL & Industrias
not really receiving the interest payments.
Rev. Rul. 84-152
(now obsolete) p.250
Swiss parent owns (1) U.S. operating sub, and (2)
Netherlands Antilles financing sub (brother-sister subsidiaries).
N.A. sub loans funds to U.S. brother-sister, with N.A. sub
funds sourced from Swiss parent corp.
Conduit analysis - U.S. to Antilles to Switzerland.
Antilles entity was not recognized. But, tax determination under the
U.S.- Swiss treaty?
But. is a “derivative benefits” concept applicable (&
5% withholding tax at source)? Yes.
Northern Indiana Public
Service p.253
Borrowing by N.A. subsidiary of U.S. parent corporation to
exploit the N.A.-U.S. income tax treaty interest income exemption.
Tax Court decision: Finance subsidiary is to be
recognized as the borrower. Treated as adequately capitalized (&
earning funds from financing activities).
What debt-equity ratio is necessary to recognize a finance
subsidiary transaction?
Other suggestions?
Limitations on “Treaty
Shopping” - Treaty & Code
1) Treaty Shopping - Article 22. Does active trade or
business exist in the treaty country?
2) Anti-conduit regulations - Code §7701(l) - conduit
entities are disregarded. p.254.
Anti-conduit regs. §1.881-3 & 4. Disregard a conduit
(i.e., an intermediate entity)?
Does the conduit itself perform significant financing
activities? Or, should conduit be disregarded? Tax “treaty override” here?
p.256
3) Economic substance doctrine - Code §7701(o).
Hybrid
Entities p.257
& cross border arbitrage
Foreign (forward) hybrid entity: Corporate status in the foreign
country but partnership (conduit) status in the U.S.
Reverse hybrid entity: Corporation for U.S. tax purposes
but flow-through entity status for foreign country tax purposes.
See §894(c)
re limitations on treaty benefits in hybrid situations. E.g., deductible
interest becomes a dividend.
Treaty Shopping
Problem 1 p.259
Swedish investors own ILL (a Swedish corp).
ILL is organized in a jurisdiction (Sweden) where all its
shareholders reside.
Article 11 of the Sweden-U.S. income tax treaty exempts the
interest payments from income tax withholding at source (i.e., the U.S.).
No Art. 22 “treaty shopping” here – all ILL owners are
Swedish residents (& are not U.S. persons).
Interest therefore is not subject to U.S. withholding.
Treaty shopping problem,
cont. Problem 2
2006 Treaty Art. 22(2)(e) - 50% rule.
(i) At least 50%
is owned by a resident for at least 1/2 of the days of year; &
(ii) Less than 50% of the
gross income is paid directly or indirectly to nonresidents of the two treaty
countries in a deductible form, i.e., the “base erosion test” is not
applicable.
No evidence here of deductible payments.
Therefore, interest payments are still immune from U.S.
withholding at source.
Problem
3 p.260
2006 Treaty Article 22(2)(e)
Sale of all stock (when? – after July 1, then not 50% of
year) to a corp. (Superrich) located in a 3rd country (i.e., Brazil - no income
tax treaty with U.S.).
Treaty benefits are probably jeopardized.
But, what if 50 percent of the stock of the Superrich
(Brazil) stock is traded on a U.S. stock exchange or in Sweden? No treaty
protection.
Cf., interest connected with active trade or business in
Sweden – see Article 22(3)(a). Must be substantial in relation to trade or
business of the resident.
Problem 4 ILL Shares
Listed on an Exchange
ILL shares are all traded on Swedish exchange.
Treaty Article 22(2)(c)(i)(A) & 22(5)(a)).
Treaty benefits are preserved if all ILL
shares are trading on the Swedish stock exchange (one of the tax treaty partner
countries). Relevance of “treasury shares”?
Why preserve tax treaty benefits in this context?
Problem 5
p.260
ILL Shares Traded & Sold
Shares are listed and 75 percent of the shares are sold
mostly to non-treaty country residents. Art. 22(2)(c)(i) says principal class
of stock to be regularly traded on a local stock exchange.
Treaty benefits preserved if 75% of shares are trading
on Sweden exchange? Must all shares (of each class of stock) must be listed?
Apparently not – Change from 1996 Model Treaty (requiring all shares to be
traded)?
Problem 6 Shares Are
Sold Directly to 3rd Country
75 percent of the ILL shares are sold directly by two
Swedish shareholders to non-treaty country (3rd country) residents.
Article 22.
Treaty benefits are denied to ILL (unless sale occurred in
last one-half of the year, and then only for that year).
Why deny the tax treaty benefit when the shares are not
publicly traded?
Problem 7
p.260
The “Base Erosion” Test
Loan from bank in Norway to Partsub (Sweden) and then loan
of these funds to Amcar, parent in U.S.
Partsub being used as a financing subsidiary,
although already an operational (?) sub.
Article 22(3) (which preserves tax treaty benefits in
certain trade or business situations) will probably not protect Partsub
since no relationship between the lending transaction & trade or bus. in
Sweden.
Ultimate question: loan directly from Norway bank to U.S.
or to a Swedish borrower?
Problem 8
p.260
Base Erosion Test
Loan from bank in Norway to sub in Sweden and then loan of
borrowed funds to parent in U.S.
Amcar (Parent corp) guarantees the loan to Partsub.
Even if OK under the treaty (Art. 22(3)), note
that the guarantee of the loan by Amcar would trigger the application of the anti-conduit
rules.
See Reg. §1.881-3(c)(2). Why does sub participate in the
transaction if the Parent corp. provides a guarantee (and then gets the funds)?
Problem
9 p.260
Base Erosion Test
Loan from (1) bank in Norway to Amcar’s sub in Sweden &
(2) then from Swedish sub to Amcar parent in U.S.
Partsub was organized shortly before the loan
agreements were concluded.
Anti-conduit rules would almost certainly apply. Reg.
§1.881-3(a)(4) factors appear to be present.
Objective for the creation of the intermediary is to reduce
U.S. income tax.
Capital
Gains p.260 Source to the Residence
Capital gains are not treated as effectively
connected with a trade or business.
See U.S. Model Income Tax Treaty, Article 13(6).
Code §865(a) - source of capital gains from sale or
exchange of personal property is at the residence of the taxpayer.
Therefore, cap. gain as foreign source income for a foreign taxpayer.
Cf., intellectual property transactions. Sale; but, contingent
payments effect – as royalty?
Withholding at Source
Mechanisms p.262
Code §§1441 & 1442 - Withholding at source at a 30% rate on FDAP income.
No withholding requirements for ECI - ETBUS income. Code
§§1441(c) & 1442(b).
Documentation to be provided to the payor: e.g., IRS Form
W-8ECI (re effectively connected income; formerly IRS Form 4224 was relevant
for this purpose).
What Amount Is Subject to
Withholding? p.262
Consider Rev. Rul. 72-87, p.262 - concerning the corporate
E&P calculation (to determine dividend status). Must the payor assume the
existence of adequate E&P for dividend characterization on the corporate
distribution? Obsoleted by Reg. §1.1441-3(c)(2)(i).
Consider other situations where recovery of tax basis
(i.e., basis is not gross income).
What if a nontaxable stock dividend? §305.
Cascading Royalties
p.263
Foreign Withholding Agent
U.S. withholding obligation on a foreign person.
Rev. Rul. 80-362 - licensing arrangements re U.S.
patent (& U.S. source):
A foreign country - license to X from A
(no foreign country income tax treaty with U.S.)
X Netherlands corporation – sublicense to Y
(Dutch-U.S. treaty royalty exemption)
Y U.S. Corporation
Royalties from X (foreign) to A are not tax exempt.
X is required to withhold at source. How?
SDI
Netherlands p.265
Withholding agent issue
SDI Bermuda licenses to
SDI Netherlands which sublicenses to
SDI USA. Why a Dutch intermediary?
Issue: Is the Netherlands to Bermuda royalty payment U.S.
sourced and subject to U.S. gross withholding at source? Held: No, not U.S.
sourced. Source disappeared in a “mixing bowl.” Is this the correct result?
No conduit argument (i.e., Aiken) made by IRS.
The SDI Bermuda deal was separate.
Held: Payments by N. A. not U.S. source.
Withholding Agent
Responsibilities p.270
Who is the withholding agent?
How does one know whether the payee is domestic or foreign?
IRS Form W-9 to show U.S. status.
Possible exception in ECI & USTB, with a representation
provided by recipient. W-8ECI.
Use an alternative approach: obtain certification from the
home country re tax status as being a resident in the other (tax treaty)
country?
Withhold gross amount and refund procedure, after
qualifying tax status is documented?
Withholding for
p.271 Compensation Income
Normal wage withholding (rather than a 30 percent flat
rate) for employee (ECI status not relevant in this situation); 30%
withholding at source for an amount paid to an independent contractor.
Rev. Rul. 70-543, p. 272, involving self-employed
individuals and horse racing operator. (1) 30% gross withholding at source is
required for fighter and golfer, and §871(b) graduated rate tax; but, (2) not
for horse racing operation (if prior IRS Form 4224 provided, now IRS Form
W-8ECI).
Defining Services Income
for Withholding Purposes
Container Corp. v. Commr. (successor to Vitro), 134 T.C. 122
(2010), aff’d. 5th Cir. (prior at p. 128).
Mexican Corp. (Vitro) charged U.S. sub a fee to guarantee
U.S. sub’s debts. IRS says failure to withhold on the guarantee fee payments
to Vitro.
Tax Court: Guarantee fee is a payment for services
and, therefore, not U.S. source income (sourced in Mexico) and, therefore, no
withholding required.
Cf., subsequently guaranty fees paid by U.S. party to
foreign guarantor treated as U.S. source income (§861(a)(9)) & withholding
at source required (?).
Partnerships &
Withholding
at Source p.275
Code §1446. The partnership must withhold an amount equal
to: (1) the allocable share of partnership income, times (2) the maximum
marginal income tax rate (§1 or §11).
Any actual distribution is not
relevant for this purpose. Note similarity to the branch tax.
The withheld (gross) amount will not equal the
amount of the net income tax liability.
Consequently, an income tax return is required to be
filed by the foreign partner. (cf., Balanovski).
Additional Withholding Tax
Regime (2010) - FATCA p.276
IRC, Chapter 4, Code §§1471-1474.
“Foreign Account Tax Compliance Act,” (FATCA), in Hiring
Incentives Act (P.L. 111-147, 3-2-2010).
Effective in 2013.
To impose a 30% withholding tax at source unless the
foreign recipient bank (§1471) or other party (§1472, non-financial foreign
entity) provides information about U.S. owners of its payments.
To be a “filter” for Chapter 3 withholding.
Taxation of U.S. Real
Property Gains (FIRPTA) p.277
Code §897 - gain by a foreign party on U.S. real
property sale is treated as ECI of USTB (even though realized by a
passive investor).
What is the tax policy reason for this special tax regime
pertinent to real property gains?
What was the prior tax regime/planning:
1) Operational income – use “net basis” election.
2) Sale and gain realization when not having a USTB –
then, U.S. income tax immunity on the disposition gain.
Defining a U.S. Real
Property Interest (FIRPTA) p.279
What is the definition of a “U. S. real property interest”
for this purpose? P.279
§897(c)(1)(A)(i). Real property interests, mines, wells,
and “associated personal property” (e.g., consider a hotel operation).
Also, leasehold interests; options to purchase;
“associated personal property.” §897(c)(6)(A)&(B).
Not including interests “solely as a creditor;” but, an
“equity kicker” loan included in tax base?
US Real Property Holding
Corporation p.280
USRPI includes an interest (e.g., stock) in a “United
States real property holding corporation” (next slide); all gain is
subject to tax, not only the U.S. property percentage. Unless all prior (5
year) internal gain recognition on real property.
Cf., sale of stock of foreign corporation (but
foreign corporation itself may have USRPI); & foreign corp. with future
accrued FIRPTA liability.
USRPHC not including publicly traded stock (except
for a 5%+ shareholder). §897(c)(3).
Definition of U.S. Real
Property Holding Corp.
Holds U.S. real property is greater than 50% of both (1) real property and (2) trade or business assets
of the corporation. §897(c)(2).
Note: comparative asset values (& foreign currency
fluctuations) could cause constant change of being above or below the 50% level.
Why exclude liquid assets from this calculation? An
“anti-stuffing rule”?
Look-through rules apply to determine FIRPTA status of a
corporation. §897(c)(4 & (5).
Treatment of the Foreign
Corporation - Special Rules
1) Sale of shares of foreign corporation is
not subject to FIRPTA; but, what if a liquidation distribution & redemption
distribution?
2) Any other distribution (in kind) by the foreign
corporation of its appreciated U.S. real property triggers gain
recognition. Code §897(d)(1).
3) Possible applicability of tax non-recognition
provisions. E.g., Rev. Rul. 84-160 (p. 282) & Code §351 drop-down of U.S.
corp. shares into a U.S. holding corp. Code §897(e).
Code §1445 Withholding
at Source p.284
Transferee must withhold 10 percent of the gross
“amount realized” by seller upon the disposition transaction. Is this the real
“final tax”?
Applies to the proceeds (including debt on
property) and not to the gain realized from the real estate sales
transaction.
A U.S. income tax return is required from the foreign
seller (to determine net gain/loss) but may not be forthcoming if no
refund status.
Cf., possible information reporting by of the disposition
gain. See §6039C.
Code §1445 Exceptions
to FIRPTA Withholding at Source
Exceptions to the withholding requirements - Code §1445(b)
(p.285):
1) Not a foreign seller, e.g., a U.S. individual.
Transferor certifies that not a foreign person.
2) Corporation is not a USRPHCo. How prove this
status when selling shares? Corporate affidavit.
3) IRS “qualifying statement” received
(re security arrangement with IRS to pay the tax).
4) Future buyer use for certain residence purposes.
5) Regularly traded shares (+/- 5%); cf. 5%+ tax.
Code §1445 Withholding
&
Entity Distributions p.286
Foreign corporate distribution in kind -
withhold 35% of the gain amount. Tax applies to the corporation
which knows its own tax basis for the distributed asset. §1445(e)(2).
U.S. corp.? 10% gross withholding on
liquidation distributions. §1445(e)(3). Shareholder tax.
Partnership & trust distributions –
1) Withhold 35% of the disposition gain
realized to the extent allocable to a foreign partner/ foreign trust beneficiary.
§1445(e)(1).
2) Withhold at 10% of the gross on a
property distribution. §1445(e)(4).
FIRPTA & Tax Treaties
p. 287
Is any FIRPTA tax immunity provided in the U.S. under an
applicable U.S. bilateral income tax treaty? No. Why? Real property situs?
See U.S. Model Treaty, Article 13, re jurisdiction to tax
real estate income – including disposition gain - in the country of situs
(including the stock of a USRPHCo.).
Note the treaty override, later-in-time rule, and phase-in
of §897 when a tax treaty override.
Financing the Foreign
Enterprise p.287
Foreign shareholder capitalizes the U.S. subsidiary with
both (1) debt and (2) equity.
Dividends are subject to possible withholding at source;
& are not deductible by the payor corp.
Interest is deductible by the payor (subject to §163(j))
and is not subject to outbound withholding (under most bilateral tax treaties).
What is “debt,” as contrasted with “equity”?
See §385 re debt/equity differentiation (p. 288).
Is Excess Deductible
Interest? p.288
“Earnings-stripping” - re (tax-exempt) interest paid to a related
party - §163(j). E.g., U.S. tax treaty exempts interest from U.S. withholding
tax.
The income tax deduction to the payor for “disqualified
interest” expense postponed when:
1) “Excess interest expense” - Interest expense above 50%
of adjusted gross income. P.289
2) Debt to equity ratio exceeds 1.5 to 1.
Applicable when a U.S. income tax treaty provides a tax
exemption or tax rate reduction on interest (latter situation: a proportionate
reduction).
Treatment of Guaranteed
Debt? p.289
The “disqualified interest” includes unrelated party
loan interest where a related foreign person guarantees the debt.
Guaranteed debt also includes debt where, e.g., the parent
corporation provides a “comfort letter.”
What is a “comfort letter”?
Not relevant when the subsidiary is the guarantor.
§163(j)(6)(D)(ii)(II). Why?
Note: U.S. Treasury Jobs Act Study (2007) re §163(j)
earnings stripping provision effectiveness.
Problem
1 p.292
Securities Income & Trading
NRA has U.S. securities transactions. Dividends of $30,000
from shares and $200,000 gains and $100,000 losses; total net income of
$130,000.
Not ETBUS - §864(b)(2)(A)(i) (safe harbor).
Capital gains are not taxable in the U.S. (& are
foreign source income).
Dividends are subject to U.S. tax in U.S. (U.S. source), so
$9,000 tax on $30,000 of dividends (30% tax rate; unless a 15% rate applies
under a U.S. income tax treaty, then $4,500 tax).
Problem
2 p.292
Excess Capital Loss
NRA has $200,000 gains and $230,000 losses; net capital
loss of $30,000.
Plus, dividend income of $30,000.
The loss of $30,000 is not available to offset the
tax on the $30,000 of dividend income (unless this capital loss is effectively
connected & taxpayer is ETBUS).
Withholding tax is imposed at the source on the dividends
(i.e., possible tax treaty reduction).
Problem 3 p.292
Discretionary Authority
Discretionary authority to buy and sell securities is to be
granted to the U.S. based broker for the foreign citizen/resident NRA.
NRA will not be treated as ETBUS.
The Code §864(b)(2) safe harbor provision (from ETBUS
status) will continue to apply to the NRA.
Problem
4 p.292
No §864(b)(2)(B) Safe Harbor
Foreign commodities dealer takes title to wheat in
U.S. and the wheat is then sold to the Government of India FOB NYC.
Income from this sale is not FDAP and, arguably,
dealer is not ETBUS (since only sporadic U.S. transactions) and, therefore, no
U.S. tax liability even though U.S. source income under the title
passage test for inventory sale.
No P.E. if an income tax treaty is applicable.
Events are solely in the U.S., but no U.S. income tax.
Problem
5 p.292
Cf., Balanovski scenario
Foreign sales reps send orders to purchasing agents
in the U.S. and goods are purchased in the name of the foreign corporation.
Orders are accepted in the foreign country.
Title is transferred at the port of destination. Customers
pay for transit insurance. Is title passage rule (outside the U.S.) recognized?
Not a USTB or P.E. (if a treaty)? Purchasing agent as not
causing USTB status? Even if USTB, foreign source income (and, therefore, no
U.S. tax)? &, No partnership arrangement.
Problem
6 p.293
Related US & Foreign Parties
Foreign corp. sells machinery parts in Europe.
Bought parts from a related company (brother-sister) in the
U.S. and took title to the parts in U.S. and delivered the parts in Europe.
Foreign corp. receives foreign source income from
the sale of inventory. U.S. tax? No.
And, no imputed U.S. tax status because the
transaction is between related companies. See Model Treaty, § 5(7), re
related corporations.
But, a possible “transfer pricing” issue?
Problem
7 p.293
Foreign Corp – Services
Parts are delivered to customers at the U.S. factory and
customers pay all shipping costs. Foreign sub receives a 20 percent commission
from U.S.
Empire receives services income and services income
is sourced where those services are rendered. Presumably, those
services (producing a sales commission) are performed outside U.S.
Model Treaty, Article 5(7) – no attribution from Colonial
to Empire for determining U.S. income tax status of Empire.
Problem
8 p.293
Royalties or Compensation?
Soprano from France made recording in L.A.; similar to the
earlier Boulez case?
Receives 10 percent of gross revenue from worldwide sales,
described as “royalties” under the contract between her and U.S. recording Co.
Holding a property interest in the copyright?
1) Copyright (royalty) or compensation?
2) Cf., tax treaty treatment: compensation (taxable) or
royalty (exempt)? See Art. 16 re entertainer taxability in the U.S.
If a royalty – income is taxed where sourced – but a treaty exemption.
Problem
9 p.293
Community Income
U.S. citizen moved from U.S. to Peru as an employee of a
sub of U.S. shipping co. He married a Peruvian citizen/resident.
Peru is a community property jurisdiction (remember Poe v.
Seaborn?) & 50-50 split?
Code §879 says community earnings belong to the working
spouse. Result here: All income is his (and any §911 exclusion
eligibility?). Similar if foreign worker spouse & U.S. non-worker.
No income tax treaty coverage of this issue.
Problem 10 p.293
Outbound Alimony & Interest
Issues re withholding obligations:
Employee returns to U.S. without his NRA wife and she has
become an ex-wife.
He sends alimony (payor location, US source) and child
support (not gross income) to Peru. Withholding on alimony, but exempt under a
Treaty, Art. 17(4) & (5).
Also, he pays (US source) interest (FDAP) to Peru bank on
his personal loan. Interest payment is subject to 30% US tax withholding at source. How does the foreign bank
protect itself?
Tax treaty applicable? Exemption for these items.
Problem
11 p.294
Partnership Services §1446
NRA partner in U.S. partnership with USTB. Equal share in
profits and losses. NRA works in Ireland.
To what extent are the services provided in the U.S.?
U.S. source income is realized if U.S. based services but not if foreign
provided services.
Code §875 partnership attribution. Required §1446
partnership withholding & actual payment is not relevant. Include a
“special allocation” provision in the partnership agreement?
Transform the NRA into an employee? Code §707.
Problem
12 p.294
U.S. Land Ownership USTB?
ETBUS? If not ETBUS, 30% withholding at source on the
$100,000(?) annual rental income, plus any real estate taxes paid by the
tenant (also gross income- total 180,000 income). And, no deductions for
expenses.
Therefore, elect Code §871(d) deemed USTB
treatment. Then, NRAs taxable on Code §1 progressive income tax rates on the net
income each treated as realizing.
U.S. Model Treaty – Article 6(5) permits the net election.
Election is binding for the future.
Problem
13 p.294
Sale of U.S. Land & FIRPTA
NRA sale of U.S. land (i.e., real property).
U.S. income tax treatment of the profit? Ordinarily capital
gain allocated to the residence.
Here - Code §897 imposes tax - FIRPTA rules.
Also – Code §1445 imposes a withholding obligation at
source on the payor/buyer.
U.S. Model Income Tax Treaty, Article 13(1), confirms that
U.S. jurisdiction exists to tax these real property gains even if NRA owners
are from a treaty jurisdiction.
Problem
14 p.294
USRPHCo Status? 50%+ Test
NRA invested in wholly owned U.S. corporation:
1) NYC apartment for $2 million
2) stock (publicly traded): $2 million
3) art gallery: $2 million (rented space; annual
lease & no renewal right)
Consider (for FIRPTA purposes) the various alternatives
concerning the relative fair market values of the several properties.
What % in U.S. real property for §897 purposes?
Note (Part d): Debt reducing value of building?
Problem
15 p.295
Foreign Corp. Stock Sale
NRA invested in wholly owned foreign corporation.
The interest in a foreign corporation is not a U.S.
real property interest. Code §897(c)(1)(A)(ii).
Sale of this stock would not be taxed under FIRPTA;
but, the stock value to be paid by a purchaser should be reduced by the
embedded potential internal federal income tax liability (FIRPTA). Unless,
making the §897(i) election & then FIRPTA applies on the stock sale.
Problem
16 p.295
Indirect U.S. Ownership
Status of Bluewater as a USRPHCo.?
Yes, became a USRPHCo. when acquiring shares of foreign
corp. (Paradise) with U.S. real property (even though U.S. assets had a low tax
basis).
40 (FMV) U.S. assets & 30 (FMV) foreign assets.
Values (40-30), not tax basis (5-10) control determination
of corp’s FIRPTA status.
See Code §897(c)(5) re attribution to U.S. Corp.
The sale of Bluewater shares by Casino (NRA) for $1 mil.
profit results in FIRPTA gain and U.S. income tax liability to Casino.
The “less than 5% rule” is not applicable.
Problem
17 p.295
Disqualified Interest & §163(j)
Interest stripping issue: Interest of $280,000 is
disqualified interest under Code §163(j)(3)(a)
–
(1) interest is paid to a “related party,” and,
(2) under the treaty no U.S. tax applies to interest.
Debt/equity ratio of 2.8:1 exceeds 1.5:1 limit. 163(j).
Disqualified interest ($30,000) results from the $280,000
interest expense over 50% ($250,000) of the adjusted taxable income:
$500,000 - resulting from gross income of $200,000 + depreciation ($20,000) +
interest expense ($280,000).
See Code §163(j)(1)(A) re adjusted taxable income.
Problem 18
p.295
Internet Commerce
Use a tax haven enterprise with only a server in the U.S.
to conduct an internet sales operation (therefore, no USTB or PE, if a tax
treaty)?
Does the failure to tax internet profits create an
unacceptable advantage for “electronic commerce” taxpayers over “bricks and
mortar” taxpayers? Should internet sales be favored?
What relevance of this question for state sales taxation in
the U.S.?
Tax Planning Problem 1
p.296
Panco to acquire U.S. real property & stocks and bonds
of U.S. real estate companies
1) Current income - 30 percent tax, unless net
election available.
2) Branch profits tax if ETBUS
3) Listed securities investments - interest and dividends,
subject to 30 percent withholding.
4) Sale of real estate - FIRPTA
5) Sale of securities - no tax, unless connected with real
estate trade or business
Problem 1, continued
6) Dividends from PANCO producing U.S. taxable income,
unless branch profits tax.
7) Use debt leveraging?? - but Section 163(j) may be
applicable.
8) Cayco -
where rendering services?
Not subject to FIRPTA.
Problem 2 Constructing
the Business Plan p.297
How much investment?
Profit projections?
Cash flow expectations?
How deal with U.S. profits?
Income tax status of the individual?
Anticipated structure and management?
Problem
3 p.297
Tax Projections
Nontax considerations, e.g., limitation of liability.
What alternative structures for tax planning?
Debt financing?
Resident alien status of individual?
Branch profits tax & FIRPTA applicable?
Summary
p.298
Investment environment in U.S. - are the tax burdens on
foreign investment less onerous than for domestic based investment? Is the
U.S. a “tax haven” (except for real estate)?
Cf., “force of attraction” rule vs. P.E. test (with only
P.E. income being taxed in U.S.).
What impact for the U.S. capital markets?
Consider, also, the focus of U.S. income tax treaties
(p.300), particularly comparing developed vs. developing country treaty
structures.