Notes_for_Internation_Tax_Final

Focus on inbound cases & not so much on the outbound Focus on Chapter 1-7 Skip 8 & 12 Skip to 5210 – 7/27/11 Class International Tax Section 1055 – General discussion about tax system in foreign countries * How do you distinguish between insiders and outsiders' * In the US, you started with citizens and only they paid tax. * They then began to include long-term residents in the US. * How about corporations' * Are they treated as foreign or domestic' * UK taxes on where your mind & management located. * The US is taxed on where you are incorporated. * Some tax on where you factory & buildings are * USA Tax System * US Individuals * Even if you renounce your citizenship just to avoid tax you are still subject to US tax. * Foreign Individuals * Section 877 – if they spend enough time in the US (183 over 3 years) then they might be taxed here regardless of their visa status * Foreign Corporation * Taxed based on permanent establishment in the country. * IRS will look and see if you are engaged in a US trade or business. * IRS will impose a withholding tax of 30% on payments made to foreign corporations. * Treaties can help reduce these amounts. * In general there are two forms of taxation for foreign entities: * Net Basis * Business income * Gross Basis * Passive income & services * Taxation of Subsidiary * APB 23 accounting pronouncement that lets you defer earnings if they are overseas and invested overseas. Don’t have to pay US tax on these earnings. Any tax deductions related to these earnings (interest) are not deductible currently. * If GE opens a branch in Mexico, the US taxes all of this income and it cannot be deferred. Branch income cannot be deferred!!!! * If the entity is disregarded, then it is usually treated as a branch. * Cook V. Tait * General theme is that US Nationals are taxed on worldwide income. Double Taxation In the current situation, you are paying 10% tax in Germany & then 35% in the US when it is repatriated. How do you relieve this tax' 1. Exemption System (Territorial Tax) – you are only tax on the income earning in the country 2. Deduction for taxes paid to other country 3. Credit for taxes paid to the other country Book also discusses using the tax law to help or hurt industry. What this does is make the IRC very complex. But if gives congress the power to impose their will Tax Arbitrage – Page 28-29 A client in a foreign country may have tax due in both countries. Along with double taxation, there are double deductions or exemptions. There are ways to reduce your tax liability by organizing in a certain way. Different countries will treat instruments in different ways. So it could be equity in one country and debt in another. It helps with tax planning of MNC. Disregarded Entity (DE) If it is not a per se corporation, you can elect to be treated as a corporation or a partnership or a disregarded entity. DE is a flow-thru entity and fiscally transparent. Section 1230 Examples – Page 53 He went through some example in the book. The foreign corporation had interest and dividends paid to them from a NYC corporation. This is US source income and it will be subject to 30% withholding, as long as they are not in a US trade or business. 1. Interest on a loan would be subject to the 30% withholding I think 2. Royalties on a US patent – 30% withholding as long as there isn’t a treaty a. This is because the patent is located and used inside the USA 3. Dividends from GE stock – 30% withholding b. The dividend is from a USA business so the withholding rate sticks 4. Capital Gains on GE Stock – not US source income (so Foreign Source) subject to withholding because it would be hard for the US to collect the tax. I think this is the securities trading exemption. 5. Capital Gains on sale of patent paid with contingent payments are treated as royalties and are US source income. c. Rentals and royalties are taxable where they are used. So for royalties it is where trademark or patent is located. d. And since this capital gain is actually a royalty because of the contingent payment there is no exemption. 6. Business in a foreign country – US cannot tax this because there is no connection 7. Same as above 8. #8 & #9 – not really sure, but if a branch is owned by a foreign corporation & operates in the US then it is subject to US taxation @ 35%. Then payments back to its foreign corporation are subject to FDAP & 30%. Tax Reform Example Income of $200 & Deductions of $100. Rate of tax is 35%. Your tax is $35. What do they mean by lowering the rate and broadening the base' They want to bring rate down & then reduce the # of deductions allowed. Income is still $200 but deductions are only $50. Still at 35% & you pay tax of $52.5 On TV they talk about broadening the base, but reducing deductions. So rates could go down and you might pay more tax because you lose deductions. Income Tax Treaties – US Model Treaty Intended to prevent: 1. Prevent tax evasion a. Sharing of taxpayer information with other taxpayer authorities to give up information on people sheltering taxable income in certain countries. 2. Prevent double taxation b. To claim the tax treaty you have to be a resident of the other country. c. The US will not sign a treaty with countries that don’t share information. i. Brazil & other South American countries do not have treaty with the USA. 1. Treaty Shopping a. You would find Brazilian countries investing in a Swiss country to then invest in the USA. They did this because the Swiss don’t have withholding requirements on FDAP payments. Brazilian company would do this to get out of withholding tax. i. USA would pay dividend to Swiss who would then pay dividend to Brazil b. The US passed laws to not allow this because you have to look thru the entities. In order to get the treaty you have to a “qualified resident” of the country trying to claim the treaty with. ii. If the Brazilian company has an actual trade or business in the treaty country, then they can take it because they are actually doing business there. 3. When are you subject to the net basis' (tax on trade or business) d. Treaties relieve net basis (business tax) by saying that if you don’t have a permanent establishment in the US, then you aren’t taxed here in the US. ii. No fixed place of business = no tax in the US e. Allows foreign companies to lend money into the US or even sell stuff in the US. iii. If you make one loan, you are not in a US trade or business. f. Countries will try and avoid permanent establishment. 4. Personal Services – Section 877 says he or she has to spend more than 183 days in the US. g. If a CPA performs services in the US from a foreign country (not in a trade or business), then there is withholding of 30%. But the treaty will help eliminate this withholding (as well as dividends, interest, capital gains, etc). h. The 30% is gross basis withholding because he isn’t treated as being in a US trade or business. 5. Real Estate i. Back in 1980’s, Congress was concerned that foreigners were buying up a lot of real estate, selling it and then not paying tax on it. j. Section 897 – FIRPTA – Foreign Investor in Real Property Tax Act iv. When a foreign corporation sells real estate, interest in real estate, or stock of a company (with more than 50% of assets in real estate), then the transaction is taxable in the USA because of effectively connected income. Deemed to be in a US trade or business. 2. Normally, this would be capital gain which isn’t treated as US source income. v. How is this enforced' 3. If the foreign person is selling to a US person, buyer has to withhold a certain % of the gain and then get refunded when they pay the tax. 4. Every real estate transaction has to have the parties say they aren’t dealing with a foreign corporation. 5. The US party & broker are liable for the withholding if they don’t withhold it. 6. Other Income k. Subject to 0% of tax. l. Gambling winnings, various fees, etc. Not much falls into this category. OECD Model Treaty – UN Model Treaty * Very tricky. Australia & New Zealand have both of these treaties Treaties can never impose taxation. It can only relieve parties of taxation. True for every country around the world. The IRC taxes parties in the US. * Japanese Company like Nissan should qualify as a Japanese residence & for their treaty. * However, they might have Subs in the US & the UK in order to trade on the markets, etc. * IRS or British taxing authorities might say they don’t qualify for the treaty (similar to Brazil example). They can go to the authorities and say that they didn’t set up this company to avoid taxes, but that they did it for a business reason. * They will probably be able to get treaty treatment. Supreme Court – treaties & IRC have equal weight * But whatever is passed last has the supreme authority * Later in time takes precedence Chapter 2 Foreign or US Source – when does it matter' Section 861 - 865 Inbound * Gross basis tax is only on US source income (not foreign source income) * Foreign passive income subject to FDAP * The gross basis tax is a withholding tax because these people don’t file tax returns and this is a last chance to tax the income. * Net basis tax – Foreign Company doing business in the US. Effectively connected income is US source income. * This is usually when you have branches operating in a foreign country. If a foreigner just gives a single loan then it wouldn’t really be net-basis. * Inbound = Foreign corporations investing in a US company Inbound Sourcing (Foreigner’s investing in the US) * When a French bank loans money in the US, the income from that money is ECI and US Source income. However, money from loans outside the US is not ECI & are foreign source income. * Gross Basis Tax * Foreigner who owns the stock of GE will have FDAP dividend & will be subject to withholding. The GE dividend is US Source Income & will have a dividend. Subpart F Income – movable income (stock, bonds, patent, and securities) * You are taxed currently on this passive style income. Attacked the abuse of moving portable income offshore. * Subpart F – only applies if more than 50% is owned by US owners (or better 5 10% US shareholders) Outbound - US company on top & foreign corporation on bottom – deferral until the profits until dividend comes back to the US Company. * Foreign Tax Credit – Outbound taxation – taxed on worldwide income but are relieved by a foreign tax credit. This is limited to foreign source income. * For financial statement purposes, all companies are consolidated. * For tax, only the US companies are consolidated. * Outbound = US investors placing money off-shore or investing money in off-shore businesses US companies (outbound US investing in UK) are taxed on their worldwide income. The source of income for US taxpayers doesn’t matter too much other than foreign tax credit calculation. * Foreign tax credit is limited to the tax on foreign source income. Interest Interest soured based on residence of Obligor (payer of interest). If you get a loan from HSBC, then they are taxable with either ECI (if branch in the US) or FDAP withholding of 30%. * Exception – interest on deposits paid by foreign branches of commercial banking will be treated as FSI even though the payer is a US Company However, if you have a branch (US Business) of a foreign corporation making payments to the outside of the US, then they actually have to withhold income. * Any interest paid by a foreign corporation is usually not subject to withholding unless they have a branch or US business. Dividends Dividends are sourced by where the company paying the dividend is located. * If a foreign business has 25% or more of income from business in the US, then they will say that is US source. Payments from US Corporation will be subject to withholding when they are making these payments to foreign companies. * Some countries have treaties in which you can reduce this rate to $0 though. Foreign Corporation making a dividend payment will be foreign source income not subject to FDAP. Rental & Royalty Rental Property or Intangible – sourced based on where the asset is being used. Example: Irish company is leasing plane to Spanish company. Rental payments from Spanish company to Irish company is subject to 30% FDAP because the plane is at JFK airport. * Rent withholding is based on were the asset is. Even when both companies are not US & the other issue is that it would be hard to collect. * If either is in a US trade or business, then this would change things because it would be Net Basis If Bayer has a trademark in the US, then the income from it will be US source income. If licensed in the US and used in the US, then it will be US source income. If payments are then made from this to foreign investors, then it will be subject to FDAP. See page 2020 – Revenue Ruling Trying to say that depending on where the trademark is held/used, that is where the source will come from. Review * If you transfer all substantial rights, then you actually own it. Doesn’t matter what you call it will be treated as a sale. * Sale is sourced where the asset is sold from * If you only license it for a short period of time, then it is a royalty. * Royalty is sourced where intangible is located Compensation for Services Rev. 84-78 – Read this revenue ruling 1. Is this a sale of the copyright or is this a license of the copyright' * Sale (you give them the entire copyright) is sourced by residence of the seller * He says if you sell then it is sourced by seller. * License (you give them the right to show the fight for 1 night – limited rights) is sourced by where it is used * Because this is like a royalty and is sourced by where it is used Personal Services Personal Services – source is where the services were performed Inventory Inventory – sourced based on where title passes. Place of sale rule. If you buy an asset in the US & sell and close transaction in Paris, then this is foreign source income. This is good for foreign tax credits. Generally the IRS will not succeed in trying to say that title passed inside the US. Title passes when risk passes. * If you manufacture instead of buy inventory – * He said you can source in three different ways: * Sourced based on books and records * IRS doesn’t like this * 50/50 Rule * You just split it up because I guess that is how the transaction works * Independent Factory Price * You have to prove that the price you are selling to affiliates is the same as non-affiliates. If so then you can book your profit as US source income and prove that you only have a profit of $1 like you said you did. * They just want to make sure that you aren’t selling to an affiliate at a cheap price and then having them book foreign source income gain on the sale of the items in the foreign countries. * This way you can increase your foreign source income. High Tech Stuff Section 2175 – Computer Software * Depending on if you sold something or just licensed it (source as sale or royalty) * If you transfer all substantial rights, then you source it as a sale & by the residence of the taxpayer. Personal Property Sale of Personal Property (Not Inventory) – sourced based on the tax home of the seller. * Exceptions * Depreciable Property – sourced by where the depreciation was used / where the property was used. * Intangible – if sold at fixed price then it is sourced by residency * Often time they aren’t sold at a fixed priced. If not a fixed price, then it is sourced like a royalty (meaning where the intangible is used) * If personal property is sold outside the US & a foreign subsidiary material participated in it, then it gets foreign source income as long as the tax rate in the country is higher than 10%. If you pay no tax (like in Bermuda), then it is US source income. * Section 2150 Sale of Real Property Sale of property in US is US source income Sale of property in the foreign country is foreign source income * If a foreign company buys the empire state building and leases to a US company, then if they have a business it will be ECI or if they don’t, then it will be FDAP income. Review of Day #1: What are examples of insiders & outsiders' * Insiders = US Citizens & US Residents (substantial presence test – 183 days) are taxed on their worldwide income. * Outsiders = US Non-Residents Nothing on Section 2190 – Scholarships, Prizes, and Awards Bank of America Tax Case Why does B of A care when it got fees to foreign people for preparing certain documents & letters' * They want to figure out if it is foreign or US source What is a letter of credit' * A form of credit checks that a company uses to show that another company has the money to pay for something. Bank of America got a fee for this letter of credit. B of A wanted it to be interest income and that would be foreign source income. The IRS says that this is in relation to B of A’s business in the US and should be taxed as services and taxed in the USA. Key takeaway is that you need to know the difference between interest payments and services. If you don’t know the answer, then you need to analyze the situation to see which applies. NO FOREIGN SUBSIDIARES ARE CONSOLIDATED – IF A FOREIGN SUBSIDAIRY PAYS A $100 DIVIDEND OR INTEREST THEN IT IS TAXABLE THERE BECAUSE IT IS NOT CONSOLIDATED. IF A FOREIGN SUBSIDAIRY PAYS THEIR OWNER A DIVIDEND, THERE IS NO DIVIDEND RECEIVED DEDUCTION BECAUSE THEY ARE NOT CONSOLIDATED. Section 2215 – Start @ #3 Problems #3 – Services income are sourced by where the services are performed. Allocation of services could be based on payroll, time, etc. Which is correct' * IRS will argue based on days in the example he said. Not sure why. * What about the employee' * He needs to allocate as well because he performed services in Canada. * There is no set answer but IRS likes to allocate based on what gives them the most money''' Not sure #4 – When you lease items, it depends on where the physical equipment is. If it is overseas, then it will be foreign source income. Even if both parties to the lease are US based it is foreign because it was used overseas. #5 – Two foreign corporations engaged in leasing transaction for a patent inside the US. Because it is a US patent, it is only of value inside the US. So, it is US source income because it is a US patent. The royalty is sourced to the US. #6 – Inventory & Sale of Personal Property * Purchase of inventory inside the US & sale outside the US – foreign source income because title passes outside the US (even if you are a US residence) * If you arrange transaction for tax avoidance in the US, then the IRS might challenge. If you pass risk (and everything else) to the other company while in the US, then it really should be US source income * Sale of cosmetics – manufactured in the US * Split between US & Foreign Source incomes because it was made in the US and then sold abroad. * Sale of Computer – personal property * Sourced by seller residence because it is not inventory. Sourced to the US because that is where the residence was. #7 – Depreciation Rule taken outside of the US – to the extend you take foreign source depreciation deductions, you allocate that amount to foreign source income * Need to reduce the gain in the US by the amount of depreciation * Basis of 400k – 200k depreciation in foreign country & 800k gain. * The first 200k of gain is sourced on where the item is located (foreign source income) * The remainder of the gain is based on the residence of the seller. #7 – Part 2 – Not a fixed price patent (intangible) – foreign source because it is treated as a royalty #9 – If you take depreciation in the US & then sell to foreigners in another country (title passes in other country & its inventory), source depreciation gain in the US because it was taken there. Source the sale to foreign country because it was inventory I guess. #10 – Section 865(i) – US company sells stock of German Subsidiary (and if the sub earned more than 50% of gross income over the last 3 years in Germany – then it is foreign source), however, 60% was in France – so it is US source because it doesn’t qualify for foreign source. * If sold in France, then you would be okay. * Sale of stock is personal property and the general rule is sourced by residence. #11 – Citibank ATM Card used to get $100 from a random ATM in France & Citibank reimbursed the French Bank. * Citi charges the dude $10. What is the source of the income' Is this services or interest' Like the B of A Case. Dude is from the US, so if he pays a fee could it be service income. What service was provided' Teacher argues that the $10 is foreign source because the service of getting money from account was provided in France. * You could argue that French Bank is providing the services & could it be sourced based off that asset. #12 – The question is about stuff manufactured in the US and sold to a subsidiary. Have to figure out how to allocate the stuff using the three methods above from earlier. Why do we care about Foreign Source Income' Example on the Board: 1. Germany has $100 of gross income & you pay $50 tax in Germany. This company is a branch of the US Company. 2. In US, you have $100 of income from Germany. * Tax of $35 in the US & this is reduced to $0 because of the credit. $15 is carried forward. In Cayman Islands, you have $100 of income alone with Germany * US tax is $70 & you get to credit the whole $50. Effective tax rate is 35% because they use the extra tax in Germany to offset the income in Cayman Island (low rate foreign source income). 1. Low tax foreign source income is preferable to US companies because it allows them to claim foreign tax credits above US tax rate (see above) & this doesn’t happen much anymore. This is only for foreign tax credit purposes. 2. Foreign Companies want foreign source income because FDAP payments are not subject to Gross basis withholding. a. They only withhold on US source income FDAP payments. Not foreign source payments. 3. If the foreign company has a US trade or business & they have foreign source income, then it is usually not taxable in the US because it isn’t US sourced. July 21st 2011 Gross Basis Taxation Foreign Corporations want gross basis taxation because if they come from a treaty country, then they can reduce the withholding tax from 30% to 0% or by a substantial amount. * He calls the 30% withholding gross basis taxation of 30%. Net-Basis Taxation If the foreign corporation doesn’t have “permanent establishment”, then it won’t be taxed on its business profits. * If there is no treaty, then you have net-basis taxation even if you don’t have PE * An agent can be PE * In foreign countries you first look to see if there is PE. They create Nexus for tax not by looking at trade or business, they look at PE. Inbound Taxation – Foreign Parties Investing in US Foreign Person – US Trade or Business Income * Are you engaged in a US trade or business' * Back in the day, if a foreign company had a trade or business in the US then it would take all income from the company worldwide and tax it. * What is a US Trade or Business' * A company comes into the US & sets up a branch – this is a US trade or business * What if you just buy the stock of a US company' * Not in a US trade or business he says, but more a passive investment. * Personal Services @ anytime during the year = US trade or business * Exception: Less than 90 days & earn less than $3000 * He said it can be tricky to figure out what is a US trade or business; however, it depends on length of time & the $ value of the transactions * Trading of Stock & Securities Safe Harbor * Not in a US trade or business if you are just buying and selling stocks. You have to buy and sell stock for your company only. * However, if you are a dealer & you make a market for securities then you are in a trade or business. No exception here because you are a dealer. * 5 years ago if the foreign company making transactions had an office building then they would be a US trade or business. * The safe harbor has changed this & you can now have an office in the US and still not be in a US trade or business. * Why do they allow this' * To let capital flow freely into the US is why they have this safe harbor. * If you start loaning out money to people, then you will be in a US trade or business. Don’t want competition between US banks and foreign hedge funds. * Broker Exception * If a foreign investor does not have a foothold in the US & you just use a broker to buy and sell stock, then this will keep you from a US trade or business. * STILL COULD BE SUBJECT TO GROSS BASIS WITHHOLDING * Like the dividend payments''' * If a partnership is considered in a US trade or business, then its partners are also considered in a US trade or business. Agent vs. Contractor * A contractor who works for multiple other people, isn’t ordered around by you, and brings his own tools * An agent is under your control, he might work only for you, and they take orders from you. * Dependent Agent – under taxpayer’s dominion and control * If the agent doesn’t have the power to sign contracts, then you will not be engaged in a US trade or business. * Independent Agent – pretty much a contractor Rev. 70-424 Read this revenue ruling Banking Rules * What is banking' * General banking activities for the public. It is much different than trading in stock and securities. Management of Real Estate – Rev. Ruling 73-522 * Foreign Corporation owns a US building and then leases it down to subsidiaries. The foreign company is just collecting rent & is not in a US trade or business. * If the foreign company has management activities in the building then you will be in a US trade or business * Operation of real property can really suck you in to taxation. * You can also elect to be treated as engaged in a US trade or business (if you are a foreign corporation). If you are getting rental payments and they are getting 30% withheld, you could get a reduced rate by just electing to pay tax which is cheap for real estate. E-Commerce LL Bean Case * If you target the US market via the internet and are making regular sales, the IRS is going to at some point say that they need to file a US tax return and be subject to US tax. Effectively Connected Income * Banks operate as branches because of the access to capital and the capital requirements. * Other businesses will act as subsidiaries in most situations * Two Tests for determining ECI for Banks * Asset test looking at passive income – did the assets generate the income' Yes, then it is ECI. * If the asset is located in the US, then it is ECI. * Business activities test – Page 166 – businesses in the US constitute a major part of the company’s business. * If the employees who generate the revenue are in a branch in the US, then it is ECI because the work was done in the US. * Foreign Source Income earned by a foreign branch in the USA is not ECI and thus cannot be attacked by the US income tax system. * Page 172 Exceptions * Foreign source income will be ECI to US trade or business when: * A bank has a branch or office or place of business in the USA, and * Rents and royalties paid from outside the US from intangible property * Branch of foreign bank that makes a loan to a foreign party * It would be very stupid for a French company have its New York branch give a loan to a French company. * Sales of inventory in the US can be ECI, unless a foreign office material participated in the sale of the inventory – Page 173-174 * Branch Deductions and Credits * Interest expense is computed under a formula. You elected either method and if you elect one you have to keep it there for 5 years. * Use specific banks debt-equity ratio * If you have assets of $100 & liabilities of 95%, then you determine the interest expense and allocate to ECI. * The IRS lets you use 95% because banks are highly leveraged and they let you use this percentage to make things easy. * You then determine how much of that debt is connected to ECI & then figure out the interest expense that is collected. * Or use world-wide debt-equity ratio * Might want to use lower ratio if it is so world-wide because you already have losses, etc. * You can use transfer pricing teams to allocate expenses to ECI in the USA. * Something can be directly allocated like NYS taxes * Page 176 – 177 * Section 882-5 * Determine how much of the interest expense is allocable to the ECI in the US. The way it does this is by figuring out how many liabilities are allocable to the US entity. Revenue Ruling 86-154 Page 180 Problems 1. Something about West African Art a. No US trade or business & probably foreign source income b. Sales person in the US does increase chance of being a US trade or business. No requirement to have PE if there isn’t any treaty i. Even though you sell inventory to a foreign company, it is still not ECI because a foreign office materially participated. And title passed out of the US. 1. If title passed inside the US, then it would be US source income. c. There is a permanent office in the US but stuff is shipped from the US. They don’t say where title passed & how much the foreign office participated. ii. If title passed in the US then you have ECI iii. He said having a permanent office makes it a US trade or business. Even if you pass title outside the US, since the foreign office didn’t contribute & you have an office in the US, then it is ECI d. No sales office in the US but has an agent who has a US office to manage sales & advertising campaign. iv. Special rule for inventory. Office of independent agent will not be included for the foreign corporation. e. Foreign source income due to inventory is ECI when you sell inventory it to a foreign company''''''' Model Treaty – Tax Treaty Provision Read Article 4 – Resident Read Article 5 – PE * Independent Agent does not cause permanent establishment. Even if you have a trade or business in the US (from independent agents doing sales), as long as you don’t hire dependent agents that can sign contracts & you don’t have a building or something, then you cannot be taxable in the US. Doesn’t matter how much business you are actually doing in the US. Read Article 7 – Business Profits Relation of Code & Treaty Provisions Sometimes there is a conflict between the Code and a Treaty. Whatever passes last will apply. Foreign person may choose not to exercise treaty rights; however, the taxpayer usually can’t have treaty rights apply to one business and then another business treated under the tax code. Branch Profits Tax Difference between operating as a Sub or Branch in the US: * If a foreign company operates as a Sub, they will pay 35% tax in the US & 30% withholding on the dividend subject to a reduction of the treaty. * If it is a branch, you will not have any dividends because it is the same company. The tax will try to impose a 35% tax on branch profits sent home to the foreign parent company. * If you didn’t have this tax, then everyone would operate as a branch. * The way they enforce is by saying if you have $100 of net equity in branch and you have sufficient E&P & then at the end of the year equity is $50, they will say there is a tax on the $50 withdrawn. * Branch profits tax can also be lowered by a treaty. * Even if the treaty doesn’t say anything about the branch profits tax, the rate will automatically be limited to the dividends rate in the treaty. APB 23 – outbound tax * For financial accounting purposes, if the funds are permanently investing the money abroad, then you don’t have to pay US tax on the subsidiaries profits. * Won’t be taxed until divided. * Only subpart-F income will be taxed Transfer Pricing – where to allocate income & expenses to related party transactions within a company’s subsidiary Page 200 Problems #2 - Treaty between African country and the US' a. Would not have PE in the US. b. What if warehouse or showroom in Chicago' i. No permanent establishment because it is the use of a warehouse c. What if further work was done while in warehouse' ii. No PE because he says it still is ancillary d. Separate office in NY' iii. Might have PE in the US although if they only did research and advertising then it really wouldn’t be PE because it is still ancillary. iv. Under article 5-4 it is still auxiliary work. e. Permanent establishment exists here #4 - Meditech, company in Delaware. f. If he qualifies under article 14 then he won’t be hit with tax v. Also says that unlikely that he would have PE. Most treaties say if he is here less than 183 days, then he won’t be subject to any tax. g. Skip the Rest of Individuals having PE Gross Basis Taxation – Non-Business US Source Income No ECI & no business in the US Collection device by the US because it is the last chance for the US to tax foreign investors before the money leaves the USA FAS 109 – accounting for income taxes ---- FIN 48 – accounting for uncertain positions FDAP – pretty much any payment out of the US that is of passive income will attract this withholding tax. Does it actually have to be a payment' * No, it could be a deal where lease payments are made on behalf of a foreigner to a US entity. If this is the case then there could be a 30% withholding. Earnings Stripping – used to make sure that foreign companies aren’t putting too much debt into US companies. * Less than 1.5:1, then you are okay If it exceeds this amount then you might be in trouble & they must net the interest expense with interest income. Can’t take excess deductions * Because they figure this is excess related party deductions and they don’t let you deduct this. Book Answer: If you have interest expense greater than 50% of net earnings, then you can’t use the amount greater than 50% of net earnings. It says that the excess is just carried forward to another year. Portfolio Interest Exemption To encourage foreign investors into the US, the IRS exempts some interest payments on certain instruments like bond debt and bank deposits. FIRPTA – normally if a foreign company sells stock in a US company there is no withholding tax because it is treated as foreign source income. * However, if you sell stock of a US company that has more than 50% of real estate income, then it is US source income & you will have FDAP or ECI. If you own a building and rent it out, then they could either have FDAP (rental payments) or ECI (business). Teacher says to elect ECI & business treatment because you can take deductions where as the FDAP withholding is 30% gross and no deductions. * FIRPTA is actually imposed as a withholding tax – so the buyer has to withhold 10% of the gross receipts of the transaction. * This can be cash, assumed mortgage, or various other amounts. * However, the teacher says the buyer can elect to file a tax return & try to get back your FIRPTA tax instead of just getting 10% withheld. * The buyer withholds the 10%, but the seller can get it back like a normal refund by filing a tax return. When you rent something out it might not be ECI because it could be your only lease. However, if you sell the property than you are in a US trade or business & have ECI. * Section 871 – teacher says elect to be taxed on real estate so you can deduct expenses towards the real estate. Withholding of 35% required when a foreign corporation distributes US real property interest & there is a gain recognized by the corporation during the distribution. * Same rule applies for Partnership as well Certain Capital Gains Not from a USA Trade or Business Generally, gains from the purchase and sale of property are not treated as FDAP income. If it is sold by a foreign person and it isn’t a US trade or business then generally there is no FDAP income. However, if sold by a foreigner who was in the US for 183 days during the year then yes, there will be 30% withholding. A treaty can apply though. Sale of Inventory & NOT in a US Trade or Business As long as they are not conducting a US trade or business the book says that generally there will be no taxation or withholding. 4280 – Problems 1. Dickens or something a. Is this guy doing business in the US' He had a lot of activity; however, he has the broker safe harbor (broker in the US & independent). Might have trading safe harbor. i. 30% withholding on the dividends during the year. 9k in gross basis withholding tax unless he can use the UK treaty. Reduce that amount to 15%. 2. No, even if losses of 200k he doesn’t get the deductions because it is gross basis withholding. Same tax 3. Dividends still subject to gross basis withholding & he gets the broker exemption 4. US Source Income – but not taxed on gross or net basis taxation b. With only 1 transaction are you really engaged in a trade or business' Is there gross basis taxation or FDAP' ii. Not FDAP because it doesn’t meet definition. This is the gain on the sale of commodity. 1. FDAP = compensation for services c. Even if worried about 1 or 2 deals, there is a safe harbor for commodities. 5. Place of sale is foreign & you would generate foreign source income d. Not really in trade or business because it is only an isolated purchase of inventory. No PE in the US because the office & fixed place of business are not attributed to parent company. 6. #7 (I think)Youngstown e. Empire – commission agent & they are performing services in Europe & they are sourced foreign because that is where they are performed. iii. Empire has foreign source income. iv. What type of income' 2. Is there a PE' No, there is not. So no tax in the US because no PE in the US & not in US trade or business. 7. #8Meany – Soprano from France f. She is getting a royalty from her services as a singer. She has no rights to own the recording so it isn’t really a royalty. It is more like compensation. So she is subject to FDAP because it is services in the US. 8. #11 g. How is Horatio taxed' v. Partnership is in a US trade or business, thusly he is in a US trade or business. vi. The income is US source & it is taxed to him whether or not it is distributed. vii. The tax on ECI income distributed will not apply because nothing was distributed. viii. Question is tricky because he worked in Ireland, BUT since he is in a partnership he is taxed where the partnership is engaged in business. 9. #12 Leonardo buys farm land h. How do they minimize US income tax' ix. What is their US income tax' 3. Undeveloped land leased to a tenant farmer doesn’t mean they are in a US trade or business. 4. They do have rent of 100k so they will have FDAP of 30% because the land is in the US and rent is sourced based on where the land is. x. Elect to be treated as a US trade or business 5. Thus, they could take deductions against their income & reduce the amount of taxation 6. Must elect because IRS might say they aren’t in a US trade or business 10. #13 Sell the Land i. Taxed in the US – Yes j. FIRPTA would have taxed either way if they elected or didn’t elect to be in a US trade or business. Inbound Taxation Only outbound income is subject to Gross Basis taxation Income from intangibles & interest from a bank & inventory can be ECI (but only with office in the US). Different Example: Three types of investors * US Taxable Investor * UBIT Investor – Not-Taxable US Entities – US Investors – Pension Funds * Foreigner The UBIT & Foreigner invest in a Cayman Fund Corporation and then invest in master partnership. The US Investor invests in a US company & then invests in the master fund. The master fund then invests in stock & securities & FDAP passive income. If it thinks it will be in a US trade or business, then it invests in a corporation that will invest in US trade or businesses. * The Cayman Fund is a blocker so that if the master partnership is in a US Trade or Business, then the partners (Cayman Fund) will be in a US trade or business, BUT the partners at the top are not in a US trade or business. * To avoid ECI for the Cayman Fund the master partnership will only invest in stock & securities or other corporations that then invest in business in the US. This way they are setting up another blocker. * If they have dividends, they won’t avoid FDAP (no FIRPTA because not real estate). If they are selling stock then they have the trading exemption. If it is interest and treated as portfolio interest then no withholding. Chapter 5 – The US tries to avoid double taxation via the Foreign Tax Credit. Countries have recently changed and have adopted treaties. Problems 1. Acme Shoes – Delaware Corp – Read this thing!!! Page 280 a. Branch not a Subsidiary. Top Co had a branch in Mexico. b. A US company with a subsidiary will pay direct & indirect taxes i. Direct is the what the subsidiary is paying ii. Indirect Taxes – Mexico will withhold money from the deemed dividend. 1. Interest payments to the US might also be subject to withholding from Mexico. Section 901 & 902 – Foreign Tax Credits 901 – Direct – US Parent is Taxpayer & you get foreign tax credit currently * Income taxes paid to Mexico by a branch * Disregarded Entity – Check the Box * If you choose to check the box and make it a disregarded entity, then there would be a Corporation in Mexico. But it is still Section 901 taxes because it is disregarded even though it is taxed like a subsidiary. * You can only check if you are not a Per Se Corporation. 902 – Indirect * Subsidiary in Mexico * No foreign tax credit until income comes home or if you pay tax on Subpart F income. * This is because the income is deferred under APB 23. 903 – In lieu of Income Taxes This section includes taxes paid in lieu of an income tax. I think it is mostly withholding and such. * Must be a substitute tax and not an additional tax. Soak-Up Tax = Foreign tax that is based off the ability to claim a foreign tax credit in the USA. This is not creditable because it pretty much is just trying to hurt the USA. * Only place losing money is the USA (because they are giving a credit) & the foreign country doesn’t lose anything. Hybrid = Flow Thru for US & Not for Foreign * Whichever company has the legal liability to pay the tax abroad is given the foreign tax credit Reverse Hybrid = US Corp & Foreign Flow Thru * Entity is treated as a separate entity and the foreign tax credit cannot be claimed until a dividend is paid. You could previously use APB 23 here for other than Subpart F Income. * Income is deferred but you get the foreign tax credit now. Congress went crazy, but this is the way the US multi-nationals could claim foreign tax credit. * US Government stopped this method last year. Partnership’s partners will also get foreign tax credit. You get a foreign tax credit for withholding FDAP tax. Gross basis tax!! Excise Tax is not Creditable – ONLY INCOME TAX ARE CREDITABLE * Might still be deductible Bank of America Case – Read this & Rev. Ruling 87-39 * Bank of American wanted a foreign tax credit * Gross Basis tax that is so far removed from income tax then you do not get a foreign tax credit. However, Congress then said if you pay gross basis tax in lieu income tax then you get a credit. This is Section 903. * If you get hit with gross and income basis tax, then you might lose the deduction on the gross basis tax. * Only foreign tax credit for income taxes paid. * In the above case, it looks more like the gross basis taxation is just some fee. “Predominate Character” of the Foreign Tax = “Income Tax in a USA Sense” I don’t think the B of A case had all of these things * Realization Requirement * Foreign tax must be imposed upon or subsequent to a realization event * Gross Receipts Requirement * Starting point for calculating the tax must be actual gross receipts * Net Income Requirement * The tax must allow for a recovery of significant cost and expenses. * I think this is just saying you have to allow deductions and costs, etc. * Must be off net income. If the company pays more than they should have for foreign income tax, then the IRS doesn’t allow you the extra amount. Can only deduct the amount you were actual charged NOT PAID. And the tax must actually be paid by the USA party. Computation of 901 & 902 Taxes Section 901 Taxes: Taxes directly paid to a foreign country from a branch or some other entity. Section 902 Taxes: - Page 335 Paid out $100 in Dividend. Foreign tax was imposed in the amount of $30. You actually distribute $70. You must do a Section 78 Gross Up by adding the tax back to the amount distributed. So of the $100, what is the US tax on that' @ 35% you get a $35 tax figure. You can credit the $30 you paid against the $35 of tax. $5 goes to the US. * The reason for the gross up is to compare apples to apples. If you don’t own 100% of the company, then you must split the foreign tax accordingly. Foreign Currency – Earnings and profits will be calculated in the functional (usual foreign) currency and the credit will be based off of that. Section 5410 Talks about Maryland state income tax being deductible & the foreign Greek tax being creditable So it is an incentive to put branches off-shore because the taxes they paid there are creditable while the taxes paid in Maryland are only deductible. You can now tier corporations down further, but only if it is a CFC – Controlled Foreign Corporation – US shareholders own more than 50%. * Old Rule * When you tier corporations of a parent company, you only get foreign tax credit 3 levels down. * New rule is now 6 says the book * There is some rule that says if you multiply the ownership percentages together you must be at least 5%. (Not sure if it is still 5% or 10%) Must own 10% to get a deemed foreign tax credit. This is voting stock. 7/28/11 Example in the Book – Talks about Esse & Gamma – Page 344 (400k dividend / 600k undistributed E&P) * 180 * This formula associates an amount of tax to the dividend. So in this case it is 120. Then you gross the dividend up to $180. I lost him here. But if the US tax rate is higher, then you can offset the entire $120 tax paid to foreign country. If foreign tax is more, then you can only use up to the US tax due Talks about Goodyear Court Case Vulcan Materials Court Case * US shareholders and Saudi shareholders. The US shareholders were the only one paid tax. They said they should be allocated all the tax because they were the ones who paid it. * IRS tried to say total profit denominator was 1 million - dividend. But taxpayers said that it was only 600k because that was their allocation of income instead of the 1 million. They said other amount should be allocated to Saudi. (Div / Accum. Profits) * Foreign tax = 902 Credit ABC Manufacturing Problem – Page 361 1. Direct Credit = 30k of foreign taxes paid a. Indirect Credit = (200k Dividend / 600k Undistributed E&P) * 300k foreign taxes paid i. $100 of foreign tax associated with the $200 dividend. ii. Then gross up dividend to $300 & credit $100 against the $105 and you would have another $5 of tax. Section 5200 – Page 407 (Foreign Source Income / Worldwide Income) * Foreign Tax = Credit Foreign Tax Credits Carryback / Forward – Back 1 year & forward 10 years. Cross-Credit – take income from Caymans (0% tax rate) & Japan (45% tax rate) and pool together so you can get the entire Japan credit since it is higher than the US 35%. This was very popular in the 60’s. * Congress said the limitation applies on a country by country basis. * Then congress split it up by industry. * In 2004, they got rid of the 13 baskets of income. * NOW, they use just passive & active taxes paid. * I think the only rule is you can’t cross credit passive and active foreign taxes paid. Example: US Source & Country A Source * Country A has 45% tax rate. * US Corporate rate is 35%. * 10% cannot be credited; but you can carryforward or back. * However, if in country B the rate is 20%, then you can credit the full amount. * Foreign source = $200 & the tax is $65. * Limitation is $70 300 * 35% = 105 * (200/300) = 70 * So they can take the entire $65. Can’t cross credit passive style income with active form income Section 5250 – what are the baskets' This section looks at just passive and active Bank or financial industry where more than 80% of income is financial services income, then it is active instead of passive. * But you need to be in the financial services business. Book Example: Acme & Argentina: * Credit of $350. Argentina said you had $200 of foreign source income * US said you had $1000 of foreign source income. * Known as a base difference * Paid tax of $700 to Argentina * But the US only allowed $350 because they only recognized the $1000 of foreign source income. Cannot elect to deduct some taxes and then credit others. You have to make an election that year to make a deduction. Section 5280 – Terry Tree #1 Terry is not getting compensation. Country D Interest Income = $10,000 & paid no foreign tax on it. * This is in the passive income basket * 10k / 150 * 42k (US tax on 150) = 2800 of tax credit limitation in passive basket. Country C business = 50k income & foreign tax of 10k Country D Business = 40k income & 20k foreign tax * C & D Business income goes into active limitation basket. * 90 / 150 * 42 = 25,200 is the tax credit limitation * He won’t get entire credit for business income & will have to Carryback 1 year or carryforward 10 years. Total Income = 150k of worldwide income. So in this example his foreign tax credit is $25,200 & he has carryforward of $4,800 and this stays in the general basket. He doesn’t get any credit on the passive income because he didn’t pay any tax. * But if they let you use the passive income then you could credit the $2800 as well. You can cross credit businesses in different countries, but you can’t cross credit between passive & active income. #2 – 99k of income from personal income in the US & 500 of dividends & paid withholding tax of $210 How much of a credit can you take' * 500/100k * 28k = $140 of credit limitation. She paid $210, but she is limited to $140; however, she can use the de minimis rule and can take a credit of up to $300. * So she can take the $210 Remember = limited by foreign source income to how much credit you can take and you are limited to two baskets of income (passive and active) and you can’t cross-credit. Role of Tax Treaty Treaty can only reduce foreign taxes. You can’t use it to reduce US taxation. Treaty cannot impose extra tax. * However some treaties will say that certain transactions in the US will be treated as Foreign Source Income. * But IRS says you can’t use this foreign source income to increase your foreign tax credit in the USA. * Savings Clause – US taxpayer will not derive any benefit from the treaty to reduce tax in the USA. US taxpayer will look at a treaty to reduce the amount of tax on gross and net basis taxation. Foreign taxpayer will look to reduce tax in the USA on gross and net basis. Mr. Filler from IBM Didn’t want to be taxed by both countries while in the USA. Taxed by France & USA. Article 15(2)(a) – won’t be taxed in both countries. But, savings clause says we don’t care about this because he is a US citizen and still subject to this. * Double taxed here because even though he was a French resident at the time he was a US citizen and couldn’t get out of the French tax. * France also didn’t want to give him a foreign tax credit because they said he wasn’t in the USA for more than 183 days and shouldn’t have had to pay any foreign tax and thus doesn’t need a foreign tax credit. 8/3/2011 Passive Foreign Investment Company Why did Congress pass' Because only 10% shareholders are taxed under the CFC rules & Subpart F income * Intended to catch US shareholders pushing money offshore. Rules said if you are a PFIC, then you will be taxed when there is an excess distribution from PFIC or if you sell your stock. * Excess is when you make a distribution of 1.25% of the prior year dividend. They charge interest and penalty & all deferred income is taxable currently. PFIC has an income & asset test If it is a bank or leasing company, or if you are receiving from a related party then it isn’t PFIC. If top company owns more than 25% of the bottom company, then you look thru the dividend to see what kind of income it was when it was earned. Similar look-thru rule exceptions under Subpart F If you have a US shareholder who meets Subpart F & PFIC, you are not taxed twice but are exempt from PFIC. * I think he said if you are not a US shareholder, then you are hit with both. Subpart F or Section 956 Income – US Company takes these amounts into income. It increases the basis in the stock of the CFC because it is paying the tax on the income of the CFC. When the CFC pays a future dividend, it comes out as previously taxed income & then this reduces basis. * Something about it could be a PFIC but not a CFC & then something about the foreign tax credit. Example: US Corp owns Japanese Corp. The CFC invests back into the US & it could be taxed on a gross basis or a net basis. * If it is a bank, then it is subject to both gross and net basis income. If it is a business & the income is not being reduced by a treaty, then you are not taxed on gross basis as well. Marketable Stock in PFIC – you can elect to mark the stock to market. It must be traded on an exchange somewhere. Problems on Page 626 – Section 6330: 1. Something about Subpart F & PFIC' a. When does PFIC apply & when does Subpart F' i. PFIC is much broader because Subpart F only applies if you are a 10% US Shareholder & the total % of all US Shareholders is 50%. 1. He talked about this mark to market exemption rule. Not sure what he means by it. ii. If you are not a US shareholder, then you are subject to PFIC. iii. If you are a US shareholder, then you are not taxed on both forms of taxation. 2. Total of 100 shares outstanding. 40 owned by US Parent company & 12 by Sam, a US individual. * Is it a PFIC not sure because you don’t know what kind of income it is yet. * Type of Income = $10 million total * $4 million of foreign source interest and dividends from non-related entities * If passive income is more than 75%, then you have PFIC. * $1.5 million in capital gains from sale of foreign company stock * This is bad income as well because it is passive. * $1 million of income of foreign business sales income * Also bad income. * $3.5 million of active business & this is not bad or passive income. * During the year, assets had an average value of $60 million and AB of $30 million. Passive income comes from $50 million of assets & AB $30 million * For asset test, you use the AB to calculate if it is a PFIC. b. It is also a CFC because of the more than 50% rule. c. 50% of assets are generating passive income. So yes, it is a PFIC. d. Section 951a – US parent and Sam will have constructive dividend. iv. Yes the parent picks up 40% of the passive income & Sam picks up 12% of the foreign income. 2. They take their % of the $6.5 million. Both would get a foreign tax credit for amounts paid in taxes because they own more than 10%. a. ASK TEACHER IF YOU GET A FOREIGN TAX CREDIT FOR PFIC TAXES PAID i. I think PFICs don’t get foreign tax credit because even though the company paid it they don’t get an allocation. e. Sam & Parent Company are not subject to PFIC because they paid tax on the CFC. f. Non-US shareholder (but US residents) is subject to PFIC. They should make a Q-Fund election and take in the income currently & then later on when you get a distribution you don’t pay tax again. g. If publically traded, you could make a mark to market election. Filing Requirements – Section 6340 Annual Information return for persons owning more than 50% of a CFC * Penalty is only $10,000 per return, but it could be imposed on the CFO or CEO. Could also get criminal penalties if you don’t file on purpose. Page 655 – Section 8600 or 8630 Does the US want to go to a territorial system' What’s wrong with Subpart F' * Complicated Proposes US go to a dividend exemption system. Dividends sent back to the US are exempt from US taxation. * Example: You earn $100 in Brazil & pay tax of $42. You get a dividend of $58 & that is not subject to tax anymore. However, if you pay withholding tax, then you can get a foreign tax credit. Teacher says most companies would borrow in the US (in order to get a deduction) and then invest in other countries. Once the dividend income comes back you pay no tax on it. You then have to allocate expenses by all businesses. Subpart F would stay though so money couldn’t be put into the Cayman’s tax free and never pay tax at all. Chapter 7 Foreign Tax Credit Limitation: FSI from Japan = 100k * 50% tax = $50k tax paid US Income = 200k * 30% tax = 90k taxes Limitation = (100k / 300k) * 90k = 30k 30k credit only because it is limited. The 20k remaining credit will carryforward or back to future years where FSI (foreign source income) is present. What if you take $100k of the $200k & put it in the Cayman Islands. You will now have (200k / 300k) * 90k = 60k limit now. So in this case you can get the full $50k foreign tax credit. * IRS doesn’t allow you to just move passive income & then claim the tax credit against active income. * You have to have two baskets: passive and active income. * FSI from Japan = (100k/300k) * 90k = 30k credit – general limitation basket * Cayman = (100k/300k) * 90 = 30k credit – passive limitation basket, but you didn’t pay any taxes here so you don’t get a foreign tax credit. * In 1986, there were 13 baskets of income. They didn’t want you cross crediting. Overall Foreign Losses Losses from foreign operations are net losses – If you have $100 of income in the US & ($100) loss in Mexico, then you can net the two figures Example: Page 678 – Overall Foreign Loss Example Look Thru Rule – not just passive because it is a dividend, you have to look thru the entity to the type of income. Interest or Dividend from CFC that is a subsidiary if it is passive income then it goes in passive basket, if it is active income then it goes to active basket, and if it is both then the passive income is treated as being distributed first. Review of Look-Thru Rule Two kinds…1 for Subpart F & 1 for PFIC Subpart F If one CFC receives Subpart F income from another CFC (all related), this is not Subpart F income as long as no tax treaty is claimed and it is business income from the paying CFC. * Japan CFC (in manufacturing business) pays rent or royalty to a Cayman CFC. Japan gets a deduction & this isn’t Subpart F income to Cayman CFC because you look-thru Subpart F to see if Japan CFC is in a business. You don’t get a foreign tax credit though I think. * What if Japan CFC had $90 of business income & $10 of interest income' The $10 is Subpart F to the Japanese CFC. When it pays $20 to the Cayman CFC, then half of the $20 is Subpart F income. The other $10 is not Subpart F income. Section 1248 if you sell the top CFC, then it will be a dividend & Subpart F income. You won’t get out of tax because of it being capital gain treatment * Now he says if you sell top CFC there will be ordinary income up to E&P. After E&P there will be capital gain. Section 964(c) if top CFC sells a lower CFC’s stock, then it is treated as a dividend to the lower CFC & it is a dividend to the extent of E&P and it will be part of Subpart F income Hybrid Transactions when there is a foreign disregarded entity & you sell the stock the IRS says no there isn’t actually any stock because it is disregarded. Hence, you are actually selling the assets of the company and not the stock. (So it is foreign source income I think) Foreign Tax Credit Limitation US Parent has two CFCs if the CFC pays interest & Spain withholds 10% then this is a direct tax & you can get a credit. If you have earnings in Spain and you pay 30% tax there, then it is an indirect tax & the parent will get a foreign tax credit gets paid as a divided to the parent. You have to have a look-thru rule for foreign tax credit. It says that if the Spanish company is engaged in manufacturing or if it is a bank doing banking activities, then all income that comes up will be in the active basket. You will look thru the interest and dividend payment to see where the income came from. If it had some passive income though, then you will have some passive income. Interest or Dividend from CFC will get look-thru treatment when they pay up to the parent company. PFIC applies to any shareholder, while Subpart F only applies to 10% US Shareholders owning more than 50%. * PFIC must have 25% of income or 50% of asset basis from passive activities. * Excess distribution greater than 125% of average distribution * They will tax you at the highest rate & tax you on the deferral. If you sell the stock you will have taxable income & pay interest. * How to avoid' * Mark to Market Election – for stock traded on the exchange. * Qualified electing fund election – you agree to pay the tax currently. PFIC must distribute income currently. More Foreign Tax Credit – Read FTC Limitation Chapter You want to try and get numerator (which is foreign source income) as high as possible so you can get a big credit. So you can allocate a lot of income to foreign source income OR you can try and allocate expenses to US source income and away from foreign source income. He pretty much just talked about trying to maximize credit by getting more foreign source income so that you don’t get limited by the % of foreign source income. He said you can do this by allocated interest to US entity and away from foreign entity in order to make income higher in the foreign country. Foreign Currency – Chapter 9 When you sell currency you compute gain on the spot market at whatever the spot market price is. The tax code has come up with a Qualified Business Unit – includes both branch and CFC, but if you just do operations there is that a QBU' * If you do business in their currency then you should use their currency for reporting purposes. A corporation, branch, and anything with a separate set of books & doing business in that currency. If it doesn’t have a separate set up books & is still a US taxpayer, then every transaction must be converted into US currency and compute currency gain and loss. If it is QBU, then you only have to compute foreign currency when it is repatriated. * If you have a foreign currency gain then it is Subpart F income. Individual must use foreign currency I think he said'!'!' Based on location of the seller so if CFC then it is foreign source. If it is from a US company, then it is US source. Section 988 Transactions: Initial borrowing and repayment of a debt will be a taxable event Buying & selling the currency in an open market is also a Section 988 transaction If you accrue interest at one rate & then when it is paid it is at another rate, you have to calculate the foreign currency translation. He talked about Swedish Krona example – Read example!!! * Converting foreign currency into a hard asset will be a taxable event. He talked about problems in book and a QBU in Paris. Section 988 transactions can also create Subpart F income. * You usually have to calculate the tax on the spot rate or average exchange rate for Subpart F income. You need to be aware that when you distribute the income there is another gain/loss because the rate you distribute at will be different than when taxes where paid on it. Chapter 10 Section 376 is intended to: #1 – Prevent assets and income from avoided tax net. Before Section 376, taxpayers would take appreciated assets and contribute them to a foreign corporation under Section 351 & then sell the stock later and avoid capital gains because it got preferential rates. a. Section 376(a) says that they would be taxed on the transaction. It is pretty much trying to get the tax due on outbound transfers of appreciated property. It applies to Section 351 outbound transfer. Applies to equipment, inventory, intangibles, etc. * Prevents contribution of appreciated property to a foreign corporation. No tax free treatment and you have a pay a tax on this. * Section 367 says that you aren’t actually contributing to a corporation, but just avoiding taxation. * Section 376(a) - Must recognize gain but cannot recognize loss on the transaction. b. Section 376(b) – not sure what this actually is Section 367 – makes sure you can’t spin off a CFC into a not-taxable transaction to a place that has low tax rates. a. Section 367(a) – must have an active trade or business to meet this exemption b. Section 367(b) - helps you not lose control of the corporation during the transaction. Another trick was to accumulate pending sales into a foreign corporation & then incorporate to defer the income. Section 332 Foreign Corp owns a US Corp you could liquidate the corporation and send the assets back to the foreign country. He says IRS won’t allow this. He then talked about an example about DC who then transfers money to FC. Section 368 – multiple ways to merge that will be tax free. * Only way a transaction gets tax free treatment that involves a foreign corporation is Section 367(b) * Foreign to Foreign * Or inbound * Outbound = Section 367(a) = last chance tax Inbound Section 351 – if foreign company has built-in loss property (capital assets), Congress will not allow the property to be attributed to the US business. * If you import the property, then you can just take a lower basis on the property. The point is to avoid importation of loss property to the US & exportation of gains to foreign countries Exception to Section 367 – capitalization of a trade or business * I think he said you can contribute most assets tax free to a foreign company as long as they are trade or business assets, you run the business, and you transfer a majority of all the assets from the company to the foreign company. Stock Tranter Go through the toll booth or sign a gain recognition agreement. So you will pay the tax a few years later. Transfer of Foreign Stock to a New Foreign Company – 5% rule * If less than 5% of voting stock, you will get non-recognition on transfer to a foreign corporation. Because it is de minimis, you don’t have to file the gain recognition agreement. * If you own 80% of voting stock, you will have to sign a gain recognition agreement which says if you sell within 5 years, you will retroactively have to pay tax on the transfer (go through the toll booth). Transfer of stock of smaller CFC & receive back stock of a bigger CFC Section 1248 gain as if you sold stock of your CFC. NOT SURE ABOUT THIS Transfer of Stock of US Company – probably not on the test If you transfer US Company stock and you own more than 50%, then you don’t get good treatment. You will be subject to 376(a). They don’t like this because it inverts the company structure. Example about DC owns all the stock of DS & then there is FC. Read example. KNOW OUTBOUND TRANSFERS OF ASSETS TO FOREIGN COMPANIES ***READ SECTION 367*** Tainted Assets – US person must recognize gain on the transfer of tainted assets because the company is not in a US trade or business. * Inventory * A/R * Certain leasing assets even if it is an active trade or business * Foreign currency NOTE: If you transfer good assets to a foreign corporation and then sell the assets, Section 367(a) will retroactively apply and you will have to pay tax on it. * Transfer of Intangibles * Section 367(d) – treats the transfer as a royalty and is taxed similar to one. This deemed royalty cannot be deducted because no tax was paid in the foreign country. * This royalty is foreign source income usually & the country that sold the deemed royalty will not be subject to withholding because it is foreign source income. * If the foreign country sells the intangible, then some of the gain is subject to US tax. The built-in gain at the time of transfer will stick to the USA. * Or you can elect to treat it as a deemed sale and pay a withholding tax on the transfer. Example – Read DC & FC Example Section 367(a) exception – exchange of US stock for foreign stock is usually tax free; however, it is not tax free here. Problems French Corporation problem & a reverse triangular merger 1. Section 367(a) – US shareholders are deemed to pay tax because this is an outbound transfer of your shares for the French shares. * Transfer of partnership will be treated as a transfer of assets overseas & is taxable under Section 367. Liquidation of US Corporation into a Foreign Parent: Normally under Section 332/337, there is no taxation on liquidation of more than 80% subsidiary. However, with a foreign company it is different because it is an outbound transaction. You will have to recognize gain on the distribution to the assets to a foreign parent. Also, you cannot claim a loss on the liquidation. Exception: Liquidate subsidiary but the assets stay in the USA for at least 10 years. There will be no gain or loss. Now the foreign company owns the assets in the USA and it will be inbound & have net basis taxation. 2. Same rule for FIRPTA & the liquidation of a property holding company. Also, if foreigner owns 100% of holding company, which owns 100% of the actual company 3. If you now distribute 3rd tier to parent, you won’t be subject to extra tax because no money has left the US system. The 2nd tier company will still pay tax & the subsidiary will still pay tax in the US. Examples: 1. Analytical company who transfers assets to wholly owned subsidiary a. Transferring the foreign currency is tainted. b. A/R will be taxed c. 10k desktop systems will be taxed too because it is inventory and will be taxed under Section 367(a) d. Copiers – could be taxed if inventory or it could be taxed under the leasing rule. Would need more facts. e. Interest in world processing program in Europe. Intangible will be subject to Section 367(b) i. If you transfer can elect to be subject to tax immediately; however, they did not elect so you have an imputed royalty. No payment is made. 1. If imputed royalty there is no deduction. Since this goes into the Cayman Island, then no worries because no tax and no deduction. f. Transferring title to a warehouse will not trigger Section 367(a) 2. 5 million dollar revenue in Cayman subsidiary – this is the word processing intangible g. This is the 368(d) royalty. They have to include $500,000 he says. h. If they sell after 3 years, then US (original seller) has to compute gain minus basis at time of transfer to subsidiary i. What if you sell the stock of the company' Same answer he says. Compute gain as if sold on day 1. 3. Operated as a branch for 3 years j. I think he is saying you have 3000 of branch losses reduced by the 500 of tainted asset losses. k. So branch losses are equal to 2500 l. Tainted assets equal 500. m. Gross branch losses of 3000 & 500 of that in year 3. Branch loss recapture of 2500. n. Also had 500 of tainted assets o. 2000 in branch loss recapture & then 500 of tainted asset loss p. Total of 2500 – main point here If you took losses in a branch you cannot incorporate it and then fail to recapture the branch losses. You can import losses and export gains without paying a toll fee Section 1248 – when you sell a CFC, you have ordinary income to the extent the CFC had earnings and profits. If it is not a CFC, then it could be all of the earnings and profits American Holdings – Pasta SPA – Problem 1. E&P of $1000 into income 2. $200 Section 367(a) Recap: 1. Prevent outbound transfer of depreciated assets. The way it works is that the transferee is not an actual corporation and thus is not allowed tax free under Section 351. Section 367(a) says this isn’t a corporation and you must recognize gain but not loss. Any outbound merger or liquidation you will normally have tax. Not just Section 351 a. If you create or incorporate an active trade or business, then you can get out of Section 367(a) because you are setting up an active business. Must transfer majority of assets & already be in a business & have employees working in this business. i. Must be engaged currently and immediately for the transfer to work. So pretty much only works if you already have a trade or business abroad. 1. You can incorporate a branch because you want to be able to defer the earnings. ii. If you sell the assets transferred after a short period of time, then you can get in trouble and have Section 367(a) apply. 2. Because it is like you are sneaking it offshore and selling it for no tax. b. Doesn’t matter for certain assets. iii. Inventory, foreign currency, A/R and intangibles 3. Or you have to incorporate the loss in the branch to get out of this he says. Or recapture the branch loss or something. 2. Outbound Liquidation – Section 332/337 – generally let you liquidate tax free. c. If foreign owner liquidates US subsidiary, then the US company has US tax because it is a last chance tax (normally if the foreign company sells US stock then it is foreign source income and no taxation). iv. However, if the assets stay in the US, then you don’t have the 367(a) hit because you are continuing as a company in the US. 4. Or FIRPTA assets can’t really move. v. Liquidate 3rd tier company stock to foreign parent. Now the 2nd & 3rd tiers are brother/sister corps and still subject to taxation. 3. If you contribute capital to a foreign corporation, you will have Section 367(a) taxation. You can’t just contribute random capital and hope to avoid gains. You will pay a toll charge here. 4. Intangibles – normally developed and deducted & credited in the US d. Sell the intangible and you will pay tax on the sale & pay tax e. If you license it then you will have to set up a deemed FMV royalty from the CFC & do a transfer pricing study to figure out the deemed royalty. vi. You want to transfer trademark & intangible well before the trademark is known. f. Or you can do nothing & then the IRS will impute a royalty vii. This fictional royalty is foreign source income & you pay tax in the US. No withholding tax though because nothing is paid. g. If 3-4 years later you well the intangible, then you have to pay a tax on the appreciation based upon the basis when you exported it & the value when it was sold. 5. Transfer stock of a foreign corporation outbound h. Less than 5% no gain recognition viii. Example: Transfer 100% of a company and only get 1% of the other company is the same here i. If you get over 5% back though, then you need to sign an agreement with the IRS saying gain will be recognized if the stock is sold later. 6. Section 367(b) – Don’t worry about Chapter 11 Permanent Establishment Concept: 1. Only worry about PE if you are coming from a treaty country. No net-basis taxation unless they have a permanent establishment in the US. 2. What is PE' a. Factory, office, warehouse, mine, computer server, etc. b. Exception: exploratory activities, place to store goods, maintenance of goods or preparatory activity will not create PE 3. What does it mean when you have PE' c. Business profits attributable from PE will be tax currently in the USA. i. Example: ECI income is when you are in an active business in the US. You are taxed on passive income though, FDAP. ii. Once you have a PE, then all items are taxable because there is PE. Lecture on Holding Company Jurisdiction – Netherlands is a Popular Choice Why use a holding company' 1. Access to significantly reduced withholding taxes on dividends, interest, and/or royalties. 2. Protect from capital gains taxation on a future disposal of the investment 3. Making it possible to re-invest profits from overseas activities in the foreign country without having to repatriate to the USA. This helps optimize cash. 4. Create and push acquisition debt down to the level of the operating company hoping to use the interest expense against local operating income. a. US Company wants to make an acquisition in country Y. It borrows money to buy shares in country Y. Let’s say there is no benefit from the interest expense in the USA. What you might try to do is get the interest expense on the level of the country you just bought. b. You provide the financing to a holding company in country Y, which then owns the operating company in country Y and these two companies try to file a consolidated return so the interest expense can be on the local level. #1 - Above Receiving royalty income from India and running it through an Ireland or Netherlands holding company is better than running it straight to the USA because there is a better treaty between the Netherlands or Ireland. * If India pays straight to the USA, it is probably 30% withholding. * If India pays to Netherlands or Ireland, then maybe it can get as low as 10% withholding. * But then if there is withholding from Ireland or Netherlands to the USA then you really aren’t ahead and you could just send it to the USA directly * You want a holding company that doesn’t have withholding taxation. He has gone treaty shopping in this example. What if instead India went through the Netherlands and into the USA' The USA has limitations in its treaties that would not allow this because it is treaty shopping. Unless however the Netherlands Company is: * Publically traded * Active business #2 – Above Private Equity Fund (located in the Cayman Islands) Holding Company (Netherlands) Japanese Company * In Japan, if the Holding Co sells the stock, then you get a lower rate in the Netherlands. However, you need to make sure that the Holding Co Country (Netherlands) doesn’t impose a tax that would offset the preferable rate. * A lot of countries say that sale of stock in another country is tax exempt in the home country. It is taxable in the foreign country though (but you can get treaty exemption) * Countries vary in how much of the company you must own to get the tax exempt treatment. * Or you have to pay a certain % of tax in the foreign country to get a tax exemption. Picture on the Slides – Reverse Hybrid Planning in the USA USA Company owns a foreign LP which is earnings interest E&P but is not paying tax because it is a corporation under the USA (deferral allowed) & a partnership in the foreign country. The LP then contributes to a Netherlands corporation, which then loans either a foreign sub or foreign holding company who loans to the foreign sub who then files a consolidated return. The reason you do this is because your money is going to the Netherlands which has better treaty treatment than in the USA. Chapter 11 There are many ways that a USA company can make sales in a foreign country. You can use an independent distributor. You ship the goods to China and sale takes place over in China which then makes it foreign source income. Open an office in foreign country. This means you have PE and will probably be taxed in general CFC in China or Subsidiary – subject to tax just like a regular Chinese company and the parent is not subject to tax in the foreign country. Example: Loss of foreign tax credit could happen from exports alone and doing sales by credit ('''). Under Section 863, the IRS might only allow 50% of the income to be foreign source income. But China might say that 100% is foreign source income. So you only get half the foreign source income (and probably half the credit), but pay 100% tax. Permanent Establishment – Why is it important' If you don’t have PE in a foreign country which we have a treaty, then your business profits are not taxable in that country. What creates a PE' * Store, workshop, factory, office, or branch. * However, no PE if only used for display and deliver of goods. Or to stock merchandise. Or sitting there waiting for processing. * Focus on Agency Rules: * If there is an independent agent in the foreign country, then this doesn’t cause PE. * However, if the dependent (employee) agent comes in and solicits sales and gets contracts signs, then you have PE in the USA. * They already have a business in the USA because of sales and doing business there. Section 11045 Cosmos Example: 1. No PE in Korea, so Cosmos is not subject to tax there 2. If they had the power to solicit orders – probably has PE here and taxable a. Independent Agent, even one that can sign contracts, does not create PE in a foreign country. Since they are legally and economically independent, the foreign principal cannot control the day-to-day activities of the agent. The agent has its own tools & facilities. Economic independent because it works for many different people. They should also have some type of risk associated with the business. 3. N/A 4. Agent has risk because if they don’t make sales, then they don’t get paid. They also aren’t exclusively working for Cosmos. They can determine sales price at which Cosmos sells stuff. Application of Treaty Rules to Electronic Commerce Treaties don’t really match well with electronic commerce. They said if you have a server in the country then you have PE. They say that if you have a server that does advertising in the country than that is PE. They also say that if you are making sales in the country even though you don’t have a server, then you have a PE. Another Cosmo problem: Brazil is in the example and article five of the treaty: 1. Cosmos had a server, etc. a. No PE here because there is no agent and the website is not controlled by Cosmos. They also say that most of the business they were doing was preparatory in Brazil. 1. Something about produce in the US sell to tax haven CFC and then sell them again to another CFC or country 2. Manufacture in the US and sell to someone in a high tax jurisdiction, but make them pay the sales agent a huge commission to a tax haven agent (maybe Ireland or something). Examples: Page 909 Title passing rule says that where the title passes that is where you determine foreign source or USA source income. Main thing is when liability passes from seller to buyer. Foreign base company sales income: buy product from related party (base company) and then selling it and capturing sales profit in the base company. If you are manufacturing in the base company and then selling it there then you are okay. I think he is saying you can’t have a US company make something and sell it for cheap to a foreign base company. You get bad treatment in this example. But if the base company transforms the asset more than 25% then you are okay and get better treatment I think. CFC in Ireland and it is supposed to be manufacturing for you, but instead you hire another unrelated manufacturing company are you then in charge of manufacturing' IRS says yes you are. Rev Ruling 75-7 – Read – But not on Exam Ashland Oil – Case – READ ABOUT BASE COMPANY SALES TREATMENT USA Company gave foreign company all of its valuable information to make 25 products. US Company had a sales company in Liberia. The foreign company sold the stuff to Liberia who then sold to other customers. IRS says this is foreign base company income. USA is trying to split the income between low tax jurisdictions. However, the IRS says that this is base company sales and it Subpart F income to the USA company. What is the rule NOW…the old cases are not the rule!!! Foreign Base Company Sales Entity If a CFC is treated a manufacturer, then it is no longer a foreign base company sales entity. If the CFC makes a substantial alteration to the product then it is treated as manufacturer. This way no foreign company base sales income. Good Activity: 1. Manages the production of the actual item 2. If they help with the raw materials, logistics, quality control testing, develop product or something else. However, if they just have a CFC somewhere that completely outsources manufacturing to a 3rd party, and then the CFC sells at a huge profit it is foreign base company sales income. If this is the case then I think the USA Company gets Subpart F income. Problems: 1. Wholly owned company in the Netherlands, etc. a. Netherlands only has good rates for holding companies. If you actually do business there, then there are high tax rates. b. Foreign base company sales income because sales are being made in a low tax jurisdiction in Switzerland. As long as the Swiss rate is below 90% of the Dutch rate. You cannot do with a branch what you can do with a subsidiary. 2. This is again foreign base company sales income as long as Swiss rate is below 90% of the Dutch rate. They just switched it up a little with #1. 3. Precision Marine Corp – something about power wells. Owns the stock of Bermuda Corp c. Sale to a related party and then the related party goes and sells somewhere else. You have captured the sales profit in Bermuda. This is only bad if Bermuda didn’t manufacture or substantially contribute to the product. d. Overall, the Bermuda Company is making a substantial contribution and thus will not be foreign base company sales. i. These rules used to be extremely difficult to get over. Making 3rd party contracts with manufacturing companies is where the market is going. The IRS used to say that 3rd parties could not be used for manufacturing and then all the base company sales would be Subpart F income. ii. However, now as long as you manage the 3rd parties you are still okay. iii. As long as company or branch or subsidiary in the tax haven makes a substantial contribution (managing 3rd party) you will not have foreign base company income subject to Subpart F even if you use a 3rd party to manufacture US Model Treaty Appendix A: 1. Article 1 – tells you what the treaty is: applies to income taxes and might give you certain rules regarding pension plans and something else 2. Article 2 – what the treaty covers – income taxes and usually nothing else 3. Article 3 – definitions 4. Article 4 – defines the residents 5. Article 5 – PE clause a. Section 5 is the independent agent rule 6. Article 6 – income from real property b. Generally taxable in the country where the property is. c. Sale of stock by Dutch company in the US is usually not taxable unless it is in a real property holding company 7. Article 7 – definition of business profits 8. Article 8 – aircraft and ships exception for international flights to relieve taxation 9. Article 9 – says that each corporation is a different entity and different corporation 10. Article 10 – Dividends paid by US Company to a foreign person may be taxed in the foreign person’s home state. However, they might also be taxable in the US. The treaty says it is 5% if you own more than 10% or 15% if you own less I think'''' d. Dutch company with no business in the US. They are only taxed on Gross Basis passive income. 11. Article 11 – interest derived in the US and owned by a resident of the Netherlands can only be taxed in the Netherlands. 0% withholding in the US. 12. Article 12 – 0% withholding on royalties 13. Article 22 – Limitations on Benefits e. Very complicated. f. Only thing on the exam is that this provision is used to prevent treaty shopping. g. If you are a resident under the treaty, then you are not limited and you can claim the treaty. i. Furthermore, you must be a qualified resident under the treaty so to avoid treaty shopping. ii. If you are not a qualified resident, then the treaty doesn’t apply to you whatsoever and you don’t get any of the benefits. 1. However, if the Dutch company used by Brazil (for treaty shopping) is publically traded or an active trade or business, then you will get the treaty. 2. Or if you were owned 100% by two countries who had treaties with the USA, then you aren’t considered treaty shopping and get the Dutch treaty. Let’s say Germany & France owned.