Assignment 1:

General overview of Intl taxation system

General overview of US international taxation
Book: 1.01-2.03
2 major categories of taxation:
Inbound taxing foreign taxpayers US income
Outbound taxing US taxpayers foreign income
Residency based taxation vs source based taxation
CEN capital export neutrality: taxpayers decision whether to invest at home
or abroad should not be affected by taxes.
CIN: capital import neutrality: All investment within a territory should bear
the same tax burden regardless of the investors country of origin.
2(d): sections 1 and 55 only apply to foreign individuals as provided by 871
and 877.
11(d): taxes imposed by 11 and 55 only apply to foreign corporations as
provided by 882.
871(b): nonresident alien ENGAGED IN A TRADE OR BUSINESS
(864(b)) in the USA is taxed only on the EFFECTIVELY CONNECTED
INCOME (864(c)).
871(a): 30% flat rate on FDAP (fixed or determinable, annual or periodical
gains, profits and income) income; most important categories being interest,
dividends, rents and royalties.
882: corporations taxable on ECI if engaged in trade or business. FDAP
income taxed at flat 30%.
Book page 17-18: The three exceptions to when nonresidents are taxed on
capital gains: 1) cap gains generated by sale of US real property or stock of
certain US real property holding corps. 2) capital gains transactions
effectively connected with the conduct of a trade or business. 3) capital gains
for nonresident aliens present in the US for 183 days or more.
Assignment 2:
Tax residence of individuals
Book: 2.04(a), 2.05, 7.02
US tax residency rules for individuals:
Citizens are taxed always.
For non-citizens:
Lawful admission (green card) IRC 7701(b)(1)(a)(i)
Substantial presence test (day cont) IRC 7701(b)(1)(a)(ii); (b)(3)
Present in the US for at least 31 days during the current year
AND
Present in the US for at least 183 days for the 3 year period
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ending on the last day of the current year using a weighted
average (x1, x1/3, x1/6 for current, last and year before)
Need 122 days each year to meet 183; or a different combo
present in the US on any day the individual is physically
present any time during that day, except commuters from
Canada and Mexico.
Dont count the days the taxpayers was unable to leave due to
sickness.
Dont count days where the taxpayer is a foreign govt
employee, teacher, student or professional athlete.
EVEN IF YOU OTHERWISE MEET THE TEST, not a
resident if individual was present for fewer than 183 days and
has a tax home in a foreign country where he/she has a closer
connection to than US.
Tax home for this purpose is taxpayers principal place of
business, or if none, his regular place of abode.
First year election IRC 7701(b)(1)(a)(iii); (b)(4)
Must be present in the US for 31 consecutive days AND
At least 75% percent of the days in the part of the current year
that begins with the first of the 31 consecutive days
Only available once the individual meets the substantial
presence test for the succeeding year; must either get filing
extension or file amended return.
Once made, the election is effective for the portion of the year
beginning with the first of the initial 31 days.
Expatriation
No effect if still resident
877A provides an exit tax;
All taxpayers property is treated as sold for FMV the day before
expatriation.
There is an exclusion amount; 627k in 2010.
Payment of tax attributable to property can be deferred until its actually
sold. 877A(b)
Deferral made on asset-by-asset basis
Waives right to treaty benefits in future on said asset
Tax levied when actually sold or death or taxpayer
Definition of covered expatriate for 877A:
Has tax liability annually in excess of set amount (145k in
2009)
has a net worth of 2 mil or more
fails to certify compliance with all US federal tax obligations
for the 5 taxable years preceding the taxable year.
Exceptions for expatriation:
dual citizen from birth and not resident of US for more than 10
yrs in the past 15 yrs.
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Expatriates US citizenship before age 18.5 and not resident for
more than 10 years total prior to expatriation.
Foreign income of US citizens working and living abroad; 911
Effectively a tax sparing provision
Qualifying individuals can exclude up to 91.5k (2010 dollars) of
foreign earned income from taxable gross income.
Only includes compensation, not pensions and annuities.
Doesnt cover personal services rendered in anticipation of or
after the conclusion of an overseas assignment.
Qualified individual is anyone:
Bona fide resident of foreign country OR
Present in a foreign country for at least 330 days in any
consecutive 12 month period.
Tax home in the foreign country.
Residence is defined by looking at factors including: taxpayers
intention, establishment of a home in the foreign country for an
indefinite period of time and participation in the activities of the
community.
Foreign nationals that are resident in the US are entitled to the same
benefits for their foreign source income while here.
When both personal services and capital are material income-
producing factors, not more than 30% of the net profits are treated as
income subject to the exclusion.
Housing cost amount, 911
Can exclude from gross income a housing cost amount
Base amount is equal to 16% of the income exclusion
multiplied by number of days of foreign residence that year;
$14,640 cap in 2010.
Anything actually paid over the base amount remains excluded
or, if paid by taxpayer, deductible, but it is limited to 30% of
the income exclusion. In 2010, this difference equaled $12,810.
Expenses that are ineligible for the exclusion are (non-
comprehensive list):
cost of buying apartment or house, capital
improvements, furniture, mortgage interest, property
taxes, wages for housekeepers, gardeners or other
laborers, any costs that are lavish or extravagant.
If employer provides housing, income still excludable. But if
employer doesnt provide it, then also deductible.
Deduction can be deferred up to 1 year.
Assignment 3:
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Entities Classification and Residence
Book 2.04(b)
US tax residency rule for Corporations:
Corporations created or organized in the US are US resident
corporations.
A foreign corporation is taxable on income effectively connected with
the conduct of a trade or business in the US, or on specified US
investment income.
How to treat entities; corp or individual?
Check-the-box regulations.
Business entity incorporated in US is a corporation for tax
Business entity formed or created under foreign law is a
corporation if its specifically listed in the regs (per se
corporation)
Business entity that isnt one of the above can elect its
classification as a transparent partnership or a nontransparent
corporation.
Default rules under check-the-box:
Reg 301.7701-2 and -3.
Corporate expatriations:
Eaton and Cooper; 7874
7874 deals with inversion gain of expatriated entity
Foreign corp buys domestic; former domestic owners still own similar
interest after purchase; after the purchase the consolidated new foreign
entity doesnt have substantial business activities in foreign country.
1.7874-2T: rules on what is substantial business activity

Assignment 4:
Source of Income part 1
Book: 3.01(a), (b), (g) and (h)
Income Source Rules
Foreign tax credit for income taxes paid to foreign countries is only
available if the taxes are paid with respect to foreign source income.
Generally, foreign entities income must be US-source to be effectively
connected income, and thus be taxable by US.
FDAP income is only subject to withholding tax if US source.
Source Rules for Interest Domestic Payor
In general interest is sourced by reference to the residence of the payor.
A domestic partnership is a US resident for this purpose if it is engaged
in a trade or business in US at any time during the tax year.
EXCEPTION: Payment of interest by a foreign branch of US bank on
deposits is foreign source income.
Source Rules for Interest: Foreign Payor
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In general, interest paid by a foreign corporation is foreign source
income.
Where a foreign corporation is engaged in a trade or business in the US
through a US branch, interest paid by the US branch is domestic source
income.
In a foreign partnership with a US trade or business, interest paid is
domestic source income if it is paid by a US trade or business of the
partnership.
However if this partnership is engaged predominantly in US
trade or business, ALL interest paid by it will be domestic
source.
Substitute interest payments (payments made by foreign borrower of
securities to the foreign lender) are treated as US source income if the
interest accruing on the transferred security would have been US
source income.
Source Rules for Dividends Domestic Payor
Generally dividend paid by a domestic corporation is US source
income.
Such dividend payment is subject to 30% FDAP withholding
rate, unless reduced by treaty.
Source Rule for Dividends Foreign Payor
Generally, dividend paid by foreign corp to foreign shareholders is not
US source and not subject to withholding tax.
However, if foreign corp is engaged in US trade or business and 25%
or more of the foreign corps gross income for preceding 3 years is US
business income, then portion of dividends attributable to US business
income is considered US source income.
Not subject to withholding tax, but instead branch profits tax.
Substitute dividend payment (payment made by borrower of stock to
the lender of stock which is equivalent to a dividend payment) is
sourced in the same manner as the dividend payment itself.
Source Rule for other gross income
Scholarships, fellowship grants, prizes and awards are considered to be
FDAP and subject to withholding tax if from US source, and if the
payment is included in gross income.
Prizes, scholarships that dont fulfill IRC 117
Source of payment made to nonresident as a scholarship etc is the
country of residence of the person making the payment.
If the scholarship recipient performs activities outside of US,
then the scholarship is foreign source income.
If US subsidiary pays a guarantee fee to its foreign parent on a loan (to
reduce interest on the loan thru guarantee), then this payment is US
income.
Notional principal contract (fixed interest paid by one party while
variable interest paid by other in reference to a notional amount);
income from NPCs is sourced in the country of the recipients
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residence, so if foreign party receives money, its foreign source
income.
However, if the NPC references US stock/dividend payments
on such stock, then it is US source income subject to FDAP.
Residence for Source Rule Purposes
Residence for purpose of source rule has own special definition.
Citizens or resident aliens who do not have a tax home in the US are
non-residents.
Nonresident aliens who have a tax home in the US are residents.
A taxpayers tax home is located at the taxpayers regular or principal
place of business.
Assignment 5:
Source of Income: Royalties, Services
Book: 3.01(c), (d)
Source Rule for Personal Services
Compensation for services performed in the US is US source income
subject to a de minimis exception.
Typically a non-resident performing services in the US is deemed to be
engaged in a US trade or business and the compensation is treated as
effectively connected income that is taxable.
However, to the extent that compensation is paid for services
performed outside the US, generally the compensation is not
subject to US taxation.
If a corporation receives income in the nature of personal
services performed by an employee or other agent, the
corporations compensation is sourced in the place where the
employee or agent performs the services.
The de minimis exception provides that compensation for services
performed by a nonresident alien temporarily present in the US is
foreign source income if the individual is not present for more than 90
days in the taxable year and the compensation doesnt exceed $3000.
The payments also must be from a foreign employer, or a foreign office
of a US employer.
Some hard sourcing instances;
Hockey player playing part US part Canada; pre-season and
post-season count towards where service was performed
Sculptors income on sculpture sourced to where he worked
rather than where it was sold
Data on server; fee for services rather than royalty for a transfer
of property if taxpayer created the property for the end-user.
of the income from transportation is US source if the trip
begins or ends in the US.
A round trip is treated as 2 separate trips.
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International communications income of a US taxpayer is
treated as 50% from US sources.
Time allocation rules for services:
Determined on the basis that most correctly reflects the proper
source of the income under the facts and circumstances of the
particular case.
Individual taxpayers determined on a time basis;
Fringe benefits determined based on location of
individuals place of work.
Individual may use alternative basis if he can show to
the satisfaction of the Commissioner that under the facts
and circumstances of the case the alternative basis more
properly determines the source of the income.
Other tests for corps; payroll proportion basis, value of service
performed basis etc.
Source Rule for Rentals and Royalties
Rentals from the lease of tangible property are sourced where the
property is located.
Royalties from the license of intangible property including patents,
copyrights, knowhow or other intellectual property are sourced
according to where the intangibles are used.
Focus is on where the legal protection of the IP is sought;
namely the country in which it will be used and be
exclusionary.
If IP is sold outright instead of licensed, but the sales proceeds are
contingent on the productivity, use, or disposition of the intangible by
the purchaser, the source of the sales proceeds is determined as if such
payments are royalties.
No cascading royalties; only the ones directly connected.
Copyright right vs. copyrighted article;
Copyright to software includes the right to make copies for
distribution, to modify, to make public performance or public
display.
Assignment 6:
Source of Income: property
3.01(e),(f)
Source Rule for Real Property
Gain or loss from the disposition of US real property or stock of a US
real property holding corp is US source income.
Gain from the sale of real property outside of US is foreign source
income.
Source Rule for Personal Property
Purchased Inventory:
Gain from the sale of purchased inventory is sourced where the
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sale take place generally the place where title passes.
HOWEVER; if transaction is structured with the primary
purpose of tax avoidance, title passage rule may not apply.
Instead look to risk of loss, location of negotiations,
execution of the agreement, location of the property
itself, the place of payment etc.
If a nonresident maintains an office or other fixed place of
business in the US, income from the sale of inventory
attributable to such place of business is sourced in the US
regardless of where title passes.
However, if the inventory is sold for the use outside of
US and a foreign fixed place of business materially
participates in the sale, it is foreign source income.
Produced Personal Property
This is different in that instead of buying and reselling, the
taxpayer PRODUCED the inventory himself.
Income from sale of produced property is allocated between
country of production and country of sale.
Once the income is sourced, taxation depends on
whether the income is effectively connected income in
the US.
Step 1: First allocate gross income to the sales activity and
production activity.
Allocation rules are in regs; 1.863-3
For natural resource, FMV at place of export is
production, difference between sale price and FMV is
sale activity.
50/50 method
Independent factory price (IFP) method: if taxpayer has
wholesale activity, and sales activity isnt very
significant, it can use this method.
Books and records method: Must get advance
permission of IRS.
When production is split between US and foreign,
percentage of which it is attributable to is determined by
percentage of adjusted basis of the production assets.
Step 2: Gross income attributed to sales and production is then
sourced.
Step 3: Expenses are allocated in accordance with regulations
Intangible Property
Sourcing of sale of intangibles depends on the nature of the
sale.
If contingent on productivity, use or disposition, then it
is sourced as if the payments were royalties.
If the sales proceeds are not contingent on the use, then
any gain is sourced by reference to the residence of the
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seller.
Non-contingent payments received for the transfer of
goodwill are sourced in the country where the goodwill
was generated.
Depreciable Personal Property
When the property that is sold is depreciable or amortizable,
then look to what portion of the gain is depreciation deductions,
and what portion is capital appreciation. So, if sold for 10k with
basis of 5k, and previous deductions of 3k, then 3k is
depreciation income and 2k is capital appreciation.
Depreciation income will be US source if the
depreciation was deducted against US taxes owed; it
will be foreign source income if it was used against
foreign source income.
Capital appreciation is sourced similarly to inventory;
passage of title.
Other Personal Property
Generally, income from sale of non-depreciable personal
property by a US resident is US source income, while any gain
from a sale by a nonresident produces foreign source income.
If the property is held by a US resident who has a foreign office
and the property can be attributed to that office, as long as the
foreign country imposes a tax higher than 10% on such income,
it is foreign source.
Exception: If US resident sells stock of a foreign affiliate in a
foreign country where the affiliate derived more than 50% of its
gross income from an active trade or business during the
preceding 3 years, any gain is foreign source income.
Also, if treaty applies, treaty can provide that it is
foreign source in case of stocks of foreign corporations.
Sales Through Offices or Fixed Places of Business in the United States
Notwithstanding all other rules, if nonresident maintains an
office or other fixed business in the US, and gain from sale is
attributable to this office, it is US source income.
Also, if US resident has office in foreign country and sells
property attributable to such office, then it is foreign source
income as long as the foreign country imposes at least a 10%
tax on such sale.
Assignment 7:
inbound business income
4.01-4.03
US Activities of Foreign Taxpayers
Nonresidents engaged in a trade or business in the US, the net
income that is effectively connected with the conduct of that trade or
business is taxed in the same manner as net income earned by a US
resident.
FDAP income from US sources earned by a nonresident is taxed on a
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gross basis at a flat 30% rate or lower tax treaty rate.
Engaged in a Trade or Business
Partners are considered to be engaged in a trade or business in US if
the partnership is engaged in a trade or business in US.
A partnership is considered to be engaged in a trade or business
in the US if a partner is so engaged and is acting as an agent of
the partnership.
A nonresident is considered to be engaged in a USTB if its activities in
the US are considerable as well as continuous and regular.
Qualitative and quantitative analysis
Activities through an agent are harder to answer.
Lewenhaupt, the Swedish guy, considered to be engaged
in a USTB.
If a foreign TP actively trades stocks, securities or
commodities, the activity can rise to the level of ToB when
made through a resident independent broker and if the
transactions are directed through an office of the taxpayer
located in the US.
Nonresident who is not a dealer can trade for his own account
through an employee or dependent agent without it rising to
ToB even if he has an office.
The threshold for establishing ToB is low.
Providing services constitutes ToB, as long as it doesnt fall
under the 3k temporarily present exception.
Effectively Connected Income
US Source Income
Defined in 864(c)
If a taxpayer is engaged in a TOBIUS, generally, all sales,
services or manufacturing income from US sources is
effectively connected income.
Income that would normally be US source investment income
is ECI if either
(1) the income is derived from assets used in the
conduct of the USTOB (asset use); OR
(2) the activities of the trade or business are a material
factor in the realization of the income. (business
activities)
Foreign Source Income
Generally, income from foreign sources is not ECI and not
taxable in the US.
Exceptions for certain foreign income attributable to a
US office or fixed place or business.
Generally the type of income the source of
which could be easily manipulated to avoid US
taxation.
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Rents and royalties from intangibles located or
used outside of US, but derived in the active
conduct of a USTOB can be ECI.
Dividends or interest from stock or securities
derived from a US trade or business by banks or
other financial institutions or by a corporation
whose principal business is trading stock or
securities are ECI even if it is income from
foreign source.
E.G, japan bank, us branch, earns interest
from loan to Canadians; its ECI if the
income is attributable to the US branch.
Foreign source income is attributable to a US office if;
(1) the office is a material factor in the
production of income; and
(2) the income is realized in the ordinary course
of the trade or business of the office.
Income Effectively Connected to a Pre-Existing Trade or Business
Arises when a corp is no longer operating but either selling its
former inventory/equipment or receiving installment payments
that are in compensation for ECI.
If the income would have been ECI in the year of sale or
performance had the entire purchase price been received, then
the income will be ECI even if received after the year of sale.
If a foreign TP ceases to conduct a USTOB and disposes of
property used in that TOB, then that property will retain its
character for 10 years after business use ceases and any gain
from its sale will still be ECI.
Effectively Connected Income Election
In some cases, foreign taxpayer can elect to have income
treated as if it is ECI.
Arises in the instance of real property and rental income; can
elect to treat it as ECI. Allows deductions for depreciation and
interest expense, higher tax on net gain vs lower tax on gross
income.
assignment 8:
allocation and apportionment of deductions
3.02
Deduction Allocation Rules
FDAP tax income of a nonresident is imposed on gross income and no
deductions are allowed.
Tax on a nonresidents income that is ECI connected with TOBIUS is
imposed on taxable income. Expenses and deductions can be allocated
against such tax.
When allocating expenses the TP must:
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(1) allocate deductions to a class of gross income; and then
(2) apportion deductions within the class of gross income
between the statutory grouping (e.g. effectively connected
income for a nonresident and foreign source income for a US
TP) and the residual grouping (i.e. everything else)
Apportionment Rules??
Allocating Interest Deduction
US Corporations
Some interest is directly allocated to a specific class of income
if the loan proceeds are applied to purchase or improve real
property and the creditor can look only to the identified
property as security.
BUT if money is borrowed for general business purposes, the
interest paid is first allocated against all of the TPs gross
income, and then is apportioned between US and foreign
sources generally according to the basis of all of TPs assets.
For purposes of this apportionment, the assets of all affiliated
corporations are taken into account. IRC 1504.
FOREIGN SUBSIDIARIES ARE NOT PART OF AN
AFFILIATED GROUP.
Interest deductions are allocated first to any interest received
from a foreign subsidiary.
Netting rule: 1.861-10
Triggers when overall indebtedness of affiliated group
increases AND overall indebtedness of the US corp
increases as well.
TAX BOOK VALUE METHOD: Apportion interest expense
according to asset basis;
Alternative tax book value method: Allows to calculate basis of
depreciated assets using straight line depreciation instead of
accelerated depreciation for the purposes of calculating interest
deduction apportionment.
Taxpayer can also use FMV method of allocating and
apportioning interest expense. Useful for USTP if US assets
have more appreciation than the foreign assets.
Foreign Corporations
Foreign corporations have allocations rules under 1.882-5
and -5T, which generally apportion larger interest deductions
against US source income.
1.882-5 is a 3 step process:
First the ForCo determines the value of US assets that
generate US ECI.
Next, the ForCo determines its US connected liabilities
by multiplying the US assets by either 50% (95% for a
bank) or by the actual ratio of worldwide liabilities to
worldwide assets.
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Last, ForCo determines the interest allocable to the US
connected liabilities under the adjusted US-booked
liabilities method or the separate currency pools
method.
Deductibility of the Interest Expense
USCo owned by ForCo must contend with whether interest
paid is deductible.
Interest paid from US subsidiary to foreign parent or other
related foreign owners may be disallowed as a deduction to the
extent that the interest is not subject to a full US tax in the
hands of the recipient and where the US subsidiary is thinly
capitalized.
Interest expense deduction may also be disallowed to a US
accrual basis taxpayer where the interest is payable to a related
party.
Research and Experimental Expenditures
Taxpayers first must allocated R&D expenses undertaken solely to
meet legal requirements imposed by a govt to the jurisdiction of that
govt.
The remainder of the R&D expenses can be allocated either using the
sales method or the gross income method.
Sales Method:
50% of the R&D deduction shall be apportioned exclusively to
the geographic location where the activities accounting for
more than half the deduction were performed. The remainder is
apportioned on the basis of where the sales resulting from the
research take place. Reg 1.861-17.
Gross income method:
25% of the R&D is allocated to the geographic location where
the activities accounting for more than half the deductions were
performed. The remainder is apportioned on the basis of gross
income, so long as the result is at least 50% of what it would be
under the sales method.
Deductions for Losses
If income from the activity which produced a loss would have been
foreign source income, then the loss generally will be apportioned
against foreign source income.
In general, loss from the sale of stock is sourced in the same manner as
gain ignoring whether the stock sold is stock of an affiliate or would
have been treated as a foreign source dividend if sold at a gain.
However, if the stock sale is attributable to an office or other
fixed POB in a foreign country, the loss is allocated against
foreign source income if a gain on the sale of stock would have
been taxable by the foreign country at 10% or more.
Loss on the sale of stock in a foreign corp is allocated against
foreign source income to the extent that dividends paid during
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the previous 24 months were treated as foreign source income.
assignment 9 & 10:
inbound investment income (interest, dividends, capital gains)
4.04 (skip a(3), a(6)), 6.03, 6.04(a-c)
Taxing Rules for Nonbusiness Income from US Sources
30% flat tax rate for certain types of nonbusiness income
Applies to interest, dividends, rents, royalties and other FDAP income
if the income is (1) includible in gross income; (2) from US sources;
(3) not effectively connected with USTOB.
Taxing Rules for Nonbusiness Interest Income
Interest is generally not subject to 30%WT because of portfolio interest
exception
Original Issue Discount
Original Issue Discount Obligation is one where the face value
exceeds the issue price.
e.g. Lend 6mil for a promise to get back 9mil in 2 years.
The 3 mil is unstated interest, and is treated as interest
which must be accrued for tax purposes by both lender
and borrower regardless of their methods of accounting
Doesnt apply to short term OID instruments.
OID accrued by nonresident lender is not subject to
30%WT until the debt instrument is sold, exchanged or
retired.
Portfolio Interest
No 30%WT if the interest paid is portfolio interest.
Portfolio interest does not apply to interest payments made to a
foreign lender who owns (directly or constructively) 10% or
more of the voting power of the stock of the borrower.
To qualify for the portfolio interest exemption, interest must be
paid on registered obligation and the issuer has to obtain a
statement that the beneficial owner is not a US person.
Portfolio interest exemption is denied for any interest
determined by reference to the receipts, sales, income or asset
appreciation of the debtor or a related person.
Interest tied to the dividend rate of the payor does not qualify as
portfolio interest.
Bank Deposits
Interest earned by nonresident investor on US bank deposits is
not subject to 30%WT even though it is US source.
Deposit interest that is effectively connected with USTOB is
taxable as business income.
Interest Substitutes
A substitute payment will have the same character as the
underlying interest payment whether the borrower is a US or
foreign borrower.
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Taxing Rules for Nonbusiness Dividend Income
Dividends from US sources are generally subject to the 30%WT.
FDAP tax doesnt EVER EVER EVER apply to dividends paid by
ForCo.
Substitute dividend payments are treated as FDAP income in the same
manner as an actual dividend.
Taxing Rules for Nonbusiness Rents and Royalties
Rental income received by nonresident is subject to 30%WT if the
activity is not TOBUS.
Royalty payments not connected with TOBUS are subject to 30%WT.
Also, sale proceeds of contingent intangibles are treated as royalty,
thus 30%WT.
Taxing Rules for Nonbusiness Income from Services
Almost never subject to 30%WT.
Pensions/annuities are almost never excluded from taxable income
(and thus never subject to 30%WT) unless they meet VERY narrow
criteria, including the service exemption under 3k, temporarily present,
and developing country pension plan exclusion)
Taxing Rules for Social Security Benefits
85% of any monthly old age, survivors, and disability benefits or
railroad retirement benefits received by a nonresident are subject to
30% WT.
Taxing Rules for Other FDAP Income
Other FDAP income subject to 30%WT includes alimony,
commissions, prizes, and gambling winnings.
Guarantee fees paid by US borrower to related ForCo which guarantees
a bank loan can constitute FDAP income.
Taxing Rules for Capital Gains
Capital gains received by nonresident from the sale of property are
almost never subject to 30%WT
Withholding income under FDAP and other 30%WT income
A withholding agent who fails to withhold will be personally liable for
the requisite tax, penalties and interest.
Withholding is required when the following criteria are met:
The recipient is a foreign person
The amount paid is US source income
The amount paid is FDAP income
The amount paid is not ECI to USTOB.
The payor or some agent of the payor is a withholding agent
No exception applies.
Responsibility for collecting 30%WT is transferred to payor by statute
1441.
Regulations provide presumptions for determining nationality of payee,
which if withholding agent relies on, he/she will not be liable.
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WITHHOLDING AGENT RULE DISCUSSION IN BOOK
170-190. REFER TO HIGHLIGHTED SECTIONS.
assignment 11:
conduit financing; limitation on benefits
4.04(a)(3), 5.05(f)
Conduit Financing
ForParent loans money to StrangeCo, who lends the money to
USSubsidiary, effectively making it a loan from ForParent to
USSubsidiary.
Normally this arrangement would result in portfolio interest exemption
qualified interest payment from USSub to intermediate unrelated party.
Unrelated partys interest payment to ForParent wouldnt be subject to
a withholding tax either.
THIS IS CONDUIT FINANCING!!
Reg 1.881-3 prevents foreign taxpayers from using intermediate
entities to obtain reduced withholding.
IRS may disregard, for the purposes of 881, the participation of one or
more intermediate entities in a financing arrangement where such
entities are acting as conduit entities.
Financing arrangement is where in a series of 2 or more
transactions, whereby one party (financing entity) loans money
or other property through one or more parties (intermediate
entities) to another party (financed entity).
An entity is an intermediate entity if the following are met:
Participation of intermediate entity reduces tax due under 801.
Participation of the intermediate entity is due to a tax evasion
scheme
The intermediate entitiy is either;
(1) related to the financing or financed entity; OR
(2) unrelated but would not have lent money to financed
entity if it wasnt for the fact that the financing entity
lent the intermediate entity.
If these requirements are met, payments from financed entity to the
intermediate entity will be re-characterized as if the payments were
made directly to the financing entity.
Treaty Shopping and Limitation on Benefits
Takes one of two forms:
Entity resident in a non-treaty country wants to get treaty
benefits; or
Entity that is resident in a treaty country wants the benefit of a
better treaty.
US is big enemy of treaty shopping; now incorporates limitations on
benefits LOB provisions in most treaties it signs.
LOB determines whether a treaty resident is a qualified person
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permitted to receive treaty benefits.
1
st
test: publicly traded test: if a corp is publicly traded, then it
is a qualified person.
2
nd
test: Ownership/base erosion test:
If n more than 50% of a corps stock is held by 3
rd
country tax-payers the ownership is met.
However, base erosion test denies treaty benefits to corp
if a companys income is used in substantial part to
meet deductible liabilities owed to noresidents.
Derivative benefits test:
If the ultimate owners would have qualified for a equal
or lower tax rate under their own treaty and if the
ultimate owners are a member of certain countries (EU,
European Economic Area, NAFTA etc)
Even then, a corporation may enjoy treaty benefits under an
active trade or business test, although the corporation is not a
qualified resident.
assignment 12:
branch taxes, earning stripping
4.05, 4.04(a)(6)
The Branch Profits Tax
The aim of the BPT is to subject income earned by foreign
corporations operating in the United States to two levels of taxation
like income earned and distributed by US corporations (tax on corp,
then tax on dividends distributed)
The BPT regime causes income to be taxed when it is earned, and an
additional 30% BPT tax is imposed when the income is repatriated
from the US branch to the foreign home office by the foreign
corporation, or is deemed to be repatriated because it is not reinvested
in the US.
The BPT is levied on the dividend equivalent amount DEA in lieu of
a secondary withholding tax on dividends paid by the foreign
corporation to its shareholders.
The dividend equivalent amount equals the ForCos earnings
and profits that are effectively connected with the conduct of a
trade or business in the US, subject to specific adjustments.
To the extent that the ECI earnings and profits is reinvested in
US assets, the DEA is decreased.
Converse is true; to the extent that invetments in qualifying US
assets decreases, DEA is increased.
The BPT on Interest
There is a 30% tax on interest paid (or deemed paid) by a
branch of a ForCo engaged in USTOB.
Two rules for taxing interest in 884(f)
For a ForCo engaged in a USTOB, interest paid by the
USTOB is treated as if paid by a domestic corporation.
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However if the interest qualifies as portfolio
interest, there is no US taxation.
To the extent that the amount of interest allowable as a
deduction under 882 in computing taxable income of
the US branch exceeds interest actually paid, the excess
shall be treated as interest paid by a fictional US
subsidiary and subject to 30% tax for notional interest
payment. Portfolio exemption doesnt apply because it
is treated as paid to a related entity.
The BPT and Secondary Withholding on Dividends
There is no further tax when the foreign corporation makes a
dividend distribution to its foreign investors.
The BPT and Income Tax Treaties
Treaties can reduce the BPT on interest payments, usually to 10
or 0 percent. Also treaties can reduce the BPT overall, or
eliminate it entirely.
Interest Stripping
When a interest payment is made from USCo to ForCo and there is a
treaty that reduces or eliminates 30%WT on such payment but USCo
still gets an interest deduction, this causes base erosion.
IRC 163 provides a thin cap rule for preventing interest stripping.
Disqualified interest is not deductible if:
The debtors debt-to-equity ratio exceeds 1.5 : 1; and
the debtors net interest expense exceeds 50% of its adjusted
taxable income.
If these two conditions are met, then disqualified interest is not
deductible. Interest is disqualified when:
It is paid to a related party and there is no US tax imposed on
the interest; OR
Paid to an unrelated party on debt guaranteed by a foreign
related person (or a related tax-exempt US person) and there is
no gross basis US withholding tax imposed on the interest.
Disallowed disqualified interest may be carried forward indefinitely
and deducted in any future year to the extent that net interest expense
in that year is less than 50%.
assignment 13:
foreign investment in us real property
4.06, 6.05
Foreign Investment in US Real Property
Operational Income
Recap; if ForCo is EIUSTOB, net rental encome is ECI taxable
in the same manner as other business income of a US taxpayer.
If ForCo is not EIUSTOB, then 30%WT. ForCo not EIUSTOB
may elect to treat the rental income as ECI which can be offset
by any appropriate deductions before applying tax. This net
basis election is irrevocable once made.
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Nonresident may not make a net basis election with respect to
US real property for a taxable year in which the taxpayer does
not derive any income from such property.
However, the excess of deductions attributable to US real
property over income from the property may be used to offset
income from the conduct of a USTOB, and may be carried back
or forward to other years as a net operating loss.
Dispositional Income
ForCo not engaged in USTOB normally has no taxable gain on
the sale of a capital asset because a capital gain of a nonresident
is normally not subject to 30%WT.
IRC 897 (FIRPTA) treats gain from the sale of a US real
property interest as if the taxpayer is engaged in a trade or
business in the US, and as if the gain is ECI.
Look-through rules for partnerships and disregarded entities.
A corporation is a US real property holding corp (USRPHC) if
on any determination date during the previous 5 years the FMV
of the corps US real property interests (USRPI) was more than
50% of the sum of the FMV of all real property held by corp
worldwide plus its business assets.
A determination date is any last day of the year, or the
day of any event that might cause the corp to become a
USRPHC.
Look-through rule to determine whether USRPHC.
Stock of publicly traded USRPHC is only deemed to be USRPI
if the seller is a more than 5% owner of such stock of that
corporation.
FIRPTA Withholding
In general, the purchaser of any US real property must withhold 10%
of the amount realized on a disposition.
Exceptions:
If the seller provides an affidavit that he is an US person, no
withholding is required.
If the asset sold is stock of a domestic corporation, if the corp
provides an affidavit that it is not a USRPHC, then no
withholding is required.
No withholding if the purchaser acquires the property as a
personal residence for less than $300,000.
assignment 14:
outbound taxation: introduction to anti-deferral regimes
chapter 10
Anti-Deferral Regimes and Controlled Foreign Corporations
Dealing with subchapter F of the code.
Aimed at preventing US taxpayers from using foreign corps to
defer US taxes by accumulating certain types of income in
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foreign base companies located in low tax jurisdictions.
Under F, certain US taxpayers are taxed immediately on certain
income earned by certain CFCs.
A corp is a CFC if US shareholders own more than 50% of the total
combined voting power of its stock or more than 50% of the stocks
total value.
US shareholder is defined a sa US person owning at least 10% of more
of the total combined voting power of the corporate stock.
If a foreign corporation is a CFC for any 30 day uninterrupted period in
a year, then every US shareholder that qualifies on the last day of the
tax year must include in income the sum of:
the shareholders pro rata share of subpart F income; and
any earnings of the CFC invested in US property.
This income is taxed as a dividend at 30%.
At the end of year, subtract actual distributions from TPs basis, add F
payments to TPs basis.
What is Subpart F Income?
Income that is easily movable to low-tax jurisdiction.
Includes income derived from insurance of US risks, foreign base
company income (FBCI), income from boycotted countries and illegal
payments.
FBCI is composed of 4 main categories:
Foreign Personal Holding Company Income FPHCI
Foreign Base Company Sales Income FBCSaI
Foreign Base Company Services Income FBCSeI
Other Foreign Base Company Income OFBCI
Foreign Personal Holding Company Income FPHCI
Generally consists of passive income such as interest, dividends, rents
royalties and net gains from the sale of assets producing these income
flows, or sale of assets considered to be dividend or interest substitutes.
Exceptions:
Interest and income derived in the active conduct of a banking
or financing business is not FBCI.
Rents and royalties are derived from an active trade or business
and are not received from related taxpayers, the receipts dont
constitute FBCI.
Rents or royalties from RELATED parties are excluded from
FPHCI if the payments are for use of property located in the
country where the CFC is organized. (same country exception)
Dividends and interest which are normally FPHCI may not be
FPHCI if received from a related person organized and engaged
in a trade or business in the same country as the CFC.
Dividends, interest, rents, royalties from a CFC which is a
related person shall not be treated as FPHCI to the extent
attributable to income of the payor which is not subpart F
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income.
Doesnt apply to payments from US corps.
Evasion technique outlined in page 354-355.
Foreign Base Company Sales Income FBCSaI
Income from property purchased from or sold to a related party if the
property is manufactured or sold for use outside the CFCs country of
incorporation.
If the goods sold by the CFC are intended for use or disposition inside
the country of its incorporation, the income is not FBCSaI.
If the goods sold are manufactured in CFCs country of incorporation,
then it is not FBCSaI.
If the goods are manufactured by CFC, it is not FBCSaI.
Branch Rule: Previous exceptions may be invalid if the sales branch
income is taxed at a rate 5% less or less than 90% of the manuf.
branchs tax rate, and vice versa. Dumb rule.
Page 362-4 discussion on branch rule.
Foreign Base Company Services Income FBCSeI
Composed of income derived from the performance of specified
services for, or on behalf of, a related person outside the country where
the CFC is organized.
If the services are performed in the country in which the CFC is
organized, the income is not FBCSeI.
If the services performed on the behalf of the parent corporation are
directly related to the sale by the CFC of property it manufactured and
are performed before the time of sale, the income is not foreign base
company services income.
Other Foreign Base Company Income OFBCI
Income from manufacture and distribution of oil and gas products
outside US is FBCI unless the products were extracted from, or for use
in, the country where CFC was organized.
Allocation and Apportionment of Deductions
Allocating the deductions and losses of the CFC amongst F income
and non-F income.
Regs under the source rules and the foreign tax credit rules apply for
this purpose.
Remaining interest distributed by either pro-rata gross income or pro-
rata asset method.
De Minimis Rule
If the gross FBCI is less than lower of 5% of the CFCs gross income
or $1million, then none of the CFCs income is treated as F income.
High Tax Exception
Any item of income that would otherwise be FBCI or insurance
income is not considered as such if the income is subject to an
effective rate of foreign income tax grater than 90% of the maximum
US corporate tax rate (31.5%).
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Adjustment to Stock Basis
Increase basis of stock in CFC by amount taxed under F.
Decrease basis of stock in CFC by amount actually paid out in
distributions.
Foreign Tax Credit
Code 960 provides a foreign tax credit to foreign income tax paid for F
income.
Discussion on page 384.
Passive Foreign Investment Companies (PFIC)
A corporation is a PFIC if it meets either the income test or the asset
test.
Under the income test, 75% of the corporations income must
be passive income.
Look through test: passive income from related parties
(25% or more ownership) is not passive income for
purposes of PFIC.
Under the asset test, a ForCo is a PFIC if at least 50% of the
corps assets by FMV are held for the production of passive
income.
Taxing US owners of PFICs:
A QEF (qualifying electing fund under 1295), which provides
information necessary to determine the income and identity of
its shareholders, electing US owners are taxed currently on their
pro rata portions of the companys actual income, subject to an
election to defer payment of tax until a distribution is made or a
disposition of stock occurs.
Deferred interest charge method allows a US owner ex post to
compute an annual inclusion based on reasonable assumption
and to defer payment of the taxes until an excess distribution
from the PFIC or a disposition of stock occurs.
Market to market election: US taxpayer may elect to recognize
gain or loss annually on the difference between the
shareholders basis at the beginning of the year and the FMV of
the stock at the end of the year.
More discussion page 393-399.
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assignment 15:
outbound taxation: intro to foreign tax credit
8.01-8.06
The Foreign Tax Credit

intro to inter-company pricing
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