Tax Issues for Foreign Investors in U.S. Films
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Tax Issues for Foreign Investors in U.S. Films



Foreign investors funding US film production companies through a US limited liability company will encounter federal tax withholding and reporting issues that should be taken into consideration when ...

Foreign investors funding US film production companies through a US limited liability company will encounter federal tax withholding and reporting issues that should be taken into consideration when forecasting investment returns.



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Tax Issues for Foreign Investors in U.S. Films Tax Issues for Foreign Investors in U.S. Films Document Transcript

  • 14 Los Angeles Lawyer July-August 2009RICHARDEWINGSEVERAL FEDERAL TAX ISSUES arise in film production financing dealswith foreign investors. The foreign investors may be interested in ascreenplay that could be produced in the United States on a relativelysmall budget but has the potential to attract A-list actors and actressesfor the leading roles. To finance production for the film, from the devel-opment stage through post-production, the producer and the foreigninvestors typically enter into a joint venture by forming a limited lia-bility company (LLC) in Delaware. If all goes well, they may use thesame LLC to invest in future films with box office potential.The popularity of the LLC structure is easy to understand. Froma corporate perspective, the LLC structure requires fewer formalitiesthan a traditional corporate structure but has the same limited lia-bility protection for its members. It has more flexibility in manage-ment, organization, and operation. Units or membership interests inan LLC are treated as a member’s personal property, and units or inter-ests that are issued to non-U.S. persons do not require any formal reg-istration under exemptions to certain federal and state securitieslaws.1From a U.S. income tax perspective, an LLC may or may not berecognized as a separate entity. It is either a disregarded entity,2 a part-nership, or a corporation. Unless the LLC agreement provides for anaffirmative election to be classified as a corporation,3 it is treated fortax purposes either as a disregarded entity or a partnership.4Unlike income from traditional C corporations, which can be taxedtwice,5 partnership income is taxed only once at the partner level. Asa result, the income, profits, deductions, and losses generated by thepartnership generally flow through the LLC to the investor on apretax basis as reflected on a Schedule K-1. Typically, investors seek-ing to maximize returns on their capital prefer this arrangement,because their distributive share of partnership income will involve onlyone level of tax.Generally, an LLC classified for U.S. tax purposes as a partner-ship may allocate items of partnership income, gains, deductions,losses, and credits and make distributions—in cash or in-kind—to itsmembers in any given taxable year. These allocations and distribu-tions reflect a member’s distributive share of partnership income, forwhich a member may incur federal and state income tax liabilities.These taxes are the direct liability of each member of the LLC.Under the U.S. tax system, foreign investors in an LLC haveexposures that are different from what U.S. investors face. Tax issuesaffecting foreign investors who are members of LLCs must be vettedat the start of a deal to avoid undesirable tax consequences.Foreign Partners in LLCsAn LLC classified as a partnership is subject to one level of tax atthe partner level, but the amount of tax payable at this level is con-tingent on the partner’s status as a domestic or non-U.S. (i.e., for-eign) person.6 Domestic U.S. investors who are partners expect topay taxes, based on their prevailing U.S. federal and state tax ratesand income and cash distributions received from the LLC, as shownon each partner’s Schedule K-1. Foreign partners may not havethese expectations. Indeed, how does a foreign partner who 1) is notphysically located in the United States, 2) does not maintain anoffice in the United States, and 3) does not have any employees orrepresentative agents in the United States, become subject to federaland state income taxes simply because of a one-time investment ina small feature film?According to a maxim of Sir Arthur Conan Doyle, “When youhave excluded the impossible, whatever remains, however improb-able, must be the truth.”7 Under the Internal Revenue Code of1986 and its accompanying regulations, if a foreign partner has busi-ness activities, offices, or employees within the United States, his orher distributive share of partnership income is deemed to be “effec-tively connected” with trade or business conducted within theUnited States.8 Effectively connected income, or ECI, is taxed at grad-uated rates.9 The Internal Revenue Service has no qualms abouttax tips BY MARSHA-LAINE F. DUNGOGTax Issues for Foreign Investors in U.S. FilmsMarsha-laine F. Dungog, a tax partner at Hobson Dungog LLP, advises clientson business tax planning matters, including cross-border film production anddistribution deals, tax credit financings, and joint ventures.
  • History of the Red MassThe Red Mass was first celebrated in Paris in 1245 and began in England about 1310during the reign of Edward I. The entire Bench and Bar would attend the Red Masstogether at the opening of each term of Court. The priest and the judges of the HighCourt wore red robes, thus the Eucharistic celebration became popularly known as theRed Mass.The tradition of the Red Mass has continued in the United States. Each year inWashington, D.C. the members of the United States Supreme Court join the President,and members of Congress in the celebration of the Red Mass at the National Shrine ofthe Immaculate Conception. Los Angeles has celebrated a Red Mass for a quarterof a century. The Mass is attended by government officials, judges, members of the legalprofession and their supporters and is open to all faiths.Portrait of St. Thomas More used withpermission of the Frick Collection, New YorkTHE ST. THOMAS MORE SOCIETY OF LOS ANGELESinvites the entire legal community to the27th ANNUAL RED MASSTHE CATHEDRAL OF OUR LADY OF THE ANGELS555 W. Temple St., Los Angeles, CaliforniaTuesday, October 6, 2009 + 5:30 p.m. MassCelebrant: Cardinal Roger MahonyHomilist: Bishop Gordon BennettRECEPTION FOLLOWING IN THE CATHEDRAL CONFERENCE CENTERBENEFACTORSThomas Patrick Beck, Esq.+ Daniel V. DuRoss, Esq. + Moreno, Becerra, Casillas & Associates + William M. Wardlaw, Esq. +Panish, Shea & Boyle, LLP + Oscar A. Acosta, Esq. + Cole Pedroza LLP + Paul Hastings, Janofsky & Walker, LLPPATRONSHon. Richard P. Byrne + Thomas P. Cacciatore, Esq. + Hon. Lawrence W. Crispo (Ret.) + Lawrence W. Dailey, Jr., Esq. + Sylvan Daroca,Esq. + Rolando Hidalgo, Esq.+ Baldo Kristovich, Esq. + Hon. Marlene Kristovich + Philip F. Lanzafame, Esq. + Anthony J. Pullara, Esq. +Rickard Santwier, Esq. + Gibert, Kelly, Crowley & Jennett LLP + Stuart Alan Chapman + Michael Norris + Metropolitan News + KevinBrogan, Esq. + Prof. Gerald T. McLaughlin + Giovanniello & Michaels LLP + Caroline Newcombe, Esq. + Philip Battaglia, Esq. +District Attorney Steve Cooley + Faiez & Fares Ennabe + Nancy Iredale, Esq.SPONSORSSuzanne L. Austin, Esq. + Hon. Victor Chavez + Nancy L. Iredale, Esq. + Roger M. Sullivan, Esq. + Hon. Lawrence Waddington (Ret.) +Prof. Scott Wood + Enrique Arevalo, Esq. + Hon. William J. Birney, Jr. + Camilla L. Broderick, Esq. + Janice H. Burrill, Esq. + Mark A.Byrne, Esq. + Jose Mariano Castillo, Esq. + Richard M. Coleman, Esq. + District Attorney Steve Cooley + Prof. Jan C. Costello + GeorgeD. Crook, Esq. + Anthony de Los Reyes, Esq. + William J. Emanuel, Esq. + Michael Scott Feeley, Esq. + Thomas L. Flattery, Esq. + Hon.Charles E. Frisco + James Gilbert, Esq.+ Margaret G. Graf, Esq. + Brian J. Heffernan, Esq. + Manuel Hidalgo, Esq. + Hon. George Kalinski+ Ronald L. Katsky, Esq. + Hon. Stephen G. Larson + Bernard E. LeSage, Esq. + Michael J. Maloney, Esq. + Phillip R. Marrone, Esq. +Sean McDonald, Esq. + Charles L. Murray III, Esq. + Lilli B. Musil, Esq. + Daniel V. Nixon, Esq. + Michael O’Connor, Esq. + Dean FrancisPace, Esq. + Armando J. Paz, Esq. + Douglas C. Purdy, Esq. + Hon. Manuel L. Real + Thomas H. Reilly, Esq. + Gilbert Rodriguez, Esq. +Patrick G. Rogan, Esq. + Robert Scoular III, Esq. + Prof. Daniel P. Selmi + Hon. John P. Shook + Richard J. Ward, Jr., Esq. + Molly M.White, Esq. + Paul C. Workman, Esq. + Tiberio Lizza, Esq. + Aide Ontiveros, Esq. + Thomas Loftus, Esq.For further information, call 626-914-8942 or e-mail: laredmass1@verizon.netL.A. St. Thomas More Society Web site:
  • positing that a domestic LLC engaged infilm production activities within the UnitedStates probably constitutes a trade or busi-ness within the United States.10 Thus, a for-eign partner’s mere ownership interest inthe LLC makes the partner the recipient ofpartnership income that is effectively con-nected to trade or business conducted withinthe United States.11 This tax issue must bediscussed with the foreign partner at thenegotiation stage of the deal, so it can betaken into account in the financing terms ofthe deal.A foreign partner may wonder how theIRS would know about the foreign part-ner’s distributive share of partnership incomefrom the LLC if the foreign partner does notfile tax returns in the United States. Theanswer is simple: The LLC is required to dis-close the existence of a foreign partner. TheIRC imposes certain obligations on a part-nership with a foreign partner regarding thereporting of tax returns and income tax,including disclosing the identities of a for-eign partner and amounts actually or con-structively received by the foreign partnerfrom the LLC.12The LLC must file a partnership return(IRS Form 1065) with the IRS if it has income,deductions, or credits to report.13 The LLCalso must provide a Schedule K-1—contain-ing the information shown on Form 1065—to each of its members,14 including foreignpartners.The LLC must withhold taxes for each for-eign partner’s distributive share of partnershipincome, even if no actual distributions aremade to the foreign partner.15 The rate ofwithholding depends on whether the foreignpartner’s distributive share of partnershipincome is ECI or not. If there is ECI, theLLC must withhold on the ECI amount at themaximum rate prescribed under the IRC,depending on the corporate or noncorporatestatus of the foreign partner. If there is no ECI,the amount of withholding is 30 percent,16unless the foreign partner provides the applic-able Form W-8 to the LLC entitling the for-eign partner to a reduced rate of withholdingor an exemption from withholding alto-gether.17 The foreign partner should presenta Form W-8 at the start of the LLC year toavoid any unnecessary withholding on the for-eign partner’s cash distributions. Obtaining atax attorney’s review of the partner’s Form W-8 is advisable, because a defective W-8 canlead to many unnecessary problems.18If the foreign partner’s distributive shareof partnership income is ECI, then the LLCmust report and pay a withholding tax underthe IRS because of the foreign partner.19 Thistax is referred to as Section 1446 withhold-ing tax. The amount of Section 1446 with-holding tax payable by the LLC generally isdetermined by multiplying the effectively con-nected taxable income (ECTI)20 allocable toeach foreign partner with the highest rate oftax to which the foreign partner is subjectunder the IRS.21 The Section 1446 with-holding tax must be paid on an installmentbasis22 by the partnership itself, regardless ofthe foreign partner’s ultimate U.S. tax liabil-ity amount23 and whether actual distribu-tions are made to the foreign partner duringthe tax year.24 It is probably in the foreignpartner’s best interests to file a U.S. tax returnin order to claim a credit for any Section1446 taxes paid by the LLC on the foreignpartner’s account. Doing so will reduce theforeign partner’s own U.S. tax liability.The LLC must file a disclosure statementwith the IRS if it has participated in certaintransactions—such as a sale, exchange, retire-ment, or other taxable disposition—that con-stitute “reportable transactions” under theIRC’s tax shelter provisions.25 The LLC—orits members taking part in a reportable trans-action—must file a disclosure statement, Form8886, with the IRS that describes the trans-action with “adequate information.”26 Thisgenerally includes information about othermembers of the LLC, including any foreignpartners.Corporate BlockersForeign investors may have a multitude of rea-sons to avoid direct investment in an LLCtaxed as a partnership, not the least of whichis the tax exposure. Most foreign investors donot relish the prospect of filing U.S. infor-mational returns as a result of LLC mem-bership and are repelled further by the like-lihood of being subject to U.S. withholdingand income taxes on amounts received (ordeemed received) from the LLC, particularlyif these investors have no other connectionsto the United States.The result is that foreign investors regu-larly invest in domestic LLCs by way of cor-porate entities known as corporate blockers.The benefit to using a corporate entity is thatit effectively blocks any income and with-holding taxes that would otherwise beimposed on the foreign investor if he or shewere to invest directly in the LLC. The tradeor business conducted within the UnitedStates by a domestic corporate entity is notattributed to the foreign investor. This meansthat mere ownership of shares in a corporateblocker will not give rise to ECI,27 nor will theLLC be required to pay Section 1446 with-holding tax, because the entity holding theLLC membership’s interests is a domesticcorporation.There are, however, several downsides tothe corporate blocker structure. The mostobvious is that a corporation is subject to twolevels of taxation. Tax is imposed once on thecorporation for income earned by the cor-poration28 and again at the shareholder levelupon the corporation’s distribution of earn-ings and profits to shareholders in the formof dividends.29 If a shareholder receiving div-idends is a foreign shareholder, the receiveddividend amount is net of withholding taxestaken out by the corporation.30A domestic corporate blocker incorpo-rated in Delaware pays federal taxes on its dis-tributive share of LLC taxable income at arate of 35 percent. A U.S. shareholder of thecorporate blocker pays an additional 35 per-cent on the dividends distributed by the cor-porate blocker because those dividends aretaxed as ordinary income (unless they arequalified dividends, in which case the applic-able rate is 15 percent).31 A foreign share-holder, on the other hand, receives the divi-dend amount net of 30 percent withholdingtax in addition to paying taxes imposed underthe tax laws of the foreign shareholder’scountry on the same dividend amount.32This outcome can be reduced or altogetheravoided33 if there is an income tax treaty inplace between the United States and the for-eign shareholder’s country of residence for taxpurposes. Most income tax treaties betweenthe United States and other countries providefor a reduced rate of withholding or an elim-ination of the withholding tax altogether oncertain dividends remitted from the UnitedStates to the foreign shareholder, provided cer-tain conditions are met.34 More recent taxtreaties also impose additional restrictionson those seeking to qualify for the eliminationof withholding tax. These are provided underthe limitation of benefits (LOB) article of theapplicable treaty.35Some foreign investors try to reduce theimpact of U.S. federal and state taxes on thedomestic corporate blocker by domiciling thecorporation in foreign jurisdictions thathave effective corporate tax rates that aresubstantially less than the corporate taxrates in the United States.36 These corpora-tions thus become foreign corporate block-ers. Other foreign investors aggressivelypursuing a maximum rate of return domicilecorporate blockers in tax haven jurisdic-tions,37 which not only provide for the incor-poration of foreign corporations but offerthe benefits of a corporate blocker structurewithout the burden of U.S. corporate taxrates.However, a foreign corporate blocker isanything but a tax-free alternative. A for-eign corporate blocker structure is still sub-ject to U.S. federal and state income taxesbased on its distributive share of partnershipincome received from the LLC, because itowns a membership interest in a domesticpartnership. The amount of taxes payableby the foreign blocker is contingent on16 Los Angeles Lawyer July-August 2009
  • REGINALD A. HOLMES, ESQ.MEDIATOR - ARBITRATOR - PRIVATE JUDGEAAA National Roster of Neutrals • Fellow, College of Commercial ArbitratorsFellow, Association for International Arbitration • Member, California Academy of Distinguished NeutralsDifficult Times, Difficult Conflicts, Expedited ResolutionsTHE HOLMES LAW FIRMTEL 1.877.FAIR-ADR (1.877.324.7237) • FAX 626.432.7223E-MAIL Rholmes@theholmeslawfirm.comwww.TheHolmesLawFirm.comSOUTHERN CALIFORNIA • ATLANTA AREA • CHICAGOLANDBusiness, Employment, and Complex International DisputesEngineering the Resolution of the World’sMost Intractable DisputesSuperb JudicialTemperamentFiercely Fair andImpartialOrderly Party DrivenProcessDeep Subject MatterKnowledge
  • whether or not its distributive share of part-nership income from the LLC is effectivelyconnected with a trade or business conductedwithin the United States. If the income isnon-ECI, it is subject to a 30 percent with-holding tax at source.38 But if the foreigncorporate blocker’s distributive share of part-nership income from the LLC is ECI, it isrequired to file a U.S. tax return and pay taxon that income at graduated rates.39The LLC’s film production business islikely to be characterized as a trade or busi-ness in the United States. One of the conse-quences is that the LLC may end up havingto pay a Section 1446 withholding taxbecause a portion of the foreign corporateblocker’s distributive share of partnershipincome from the LLC is ECI. Additionally,a foreign corporate blocker with ECI may besubject to an additional tax known as thebranch profits tax.40 Generally, the branchprofits tax is a 30 percent tax on the foreignblocker’s earnings and profits (withoutdiminution as a result of any distributionsmade by the foreign blocker during the tax-able year) that are attributable to incomeeffectively connected (or treated as effec-tively connected) with a trade or businessconducted within the United States.41 Thereality is that a foreign corporate blockermay ultimately end up with tax results sim-ilar to those arising from a U.S. corporateblocker’s ownership, on behalf of a foreigninvestor, of LLC membership interests.Tax treaties do play a critical role in reduc-ing the overall amount of U.S. tax liability duefrom any foreign entity. Tax treaties enteredinto between the United States and othercountries can provide for reduced rates ofwithholding or elimination of withholding oncertain dividends received by a foreigninvestor. The tax treaties can also determinethe imposition of branch profits taxes. Butbefore any review of the tax treaties applic-able to a foreign partner, counsel must ensurethat the foreign partner is truly foreign42 andthat the structure meets the criteria set forthin the LOB provisions found in most U.S. taxtreaties.43Ultimately, the tax issues in a film financ-ing deal with a foreign investor componentare resistant to the use of the corporateblocker as a “one size fits all” solution. Thebest approach for dealing with the addi-tional tax burden triggered by foreigninvestors in a film project is to flag all issuesat the outset and discuss these with clientsand foreign investors to formulate the mostsensible solution. ■1 Regulation S establishes safe harbor exemptionsfor the registration of securities issued by issuers anddistributors that are offered to and purchased bynon-U.S. persons. See generally Security Act ReleaseNo. 6863 (Apr. 24, 1990), 55 Fed. Sec. L. Rep.(CCH) ¶18,306 (May 2, 1990).2 Technically, the Treasury Regulations do recognizeat least one type of LLC—the single member limitedliability company, which is treated by default as a dis-regarded entity. See Treas. Reg. §301.7701-3(b).3 See generally Treas. Reg. §§301.7701-1 to 301.7701-4. For a state-by-state survey of LLC tax statutes, seegenerally COMMITTEE ON STATE TAXATION, 50 STATESURVEY ON LLC/LLP TAXES (2004).4 The default classification is contingent on the num-ber of members of the LLC. An LLC with one mem-ber is treated as a disregarded entity, while an LLCwith two or more members is treated as a partnership.See Treas. Reg. §301.7701-3.5 Corporate income is taxed at the corporate level andthen at the shareholder level when distributed as div-idends. See generally BORIS I. BITTKER & JAMES S.EUSTICE, FEDERAL INCOME TAXATION OF CORPORATIONSAND SHAREHOLDERS §1.01 (2000 ed.).6 See generally I.R.C. §7701(a)(30), which defines a“U.S. Person” as a citizen or resident of the UnitedStates, a domestic partnership, a domestic corporation,any estate (except foreign estates), and any trust (pro-vided certain requirements are met).7 ARTHUR CONAN DOYLE, THE SIGN OF THE FOUR(1890); see (site visited Feb.20, 2009).8 See generally I.R.C. §871(b).9 Id.10 I.R.C. §864(b) provides a very limited definition of“U.S. trade or business.” Exactly what constitutes atrade or business within the United States has been thesubject of various IRS rulings and court cases over theyears. See generally JOEL D. KUNTZ & ROBERT J.PERONI, U.S. INTERNATIONAL TAXATION §C.104(2009).11 See I.R.C. §875 and Treas. Reg. §1.875-1, whichprovide that a foreign partner’s ownership in a part-nership is considered to be engagement in a trade orbusiness within the United States.12 The partnership is also subject to certain backupwithholding and information reporting obligationswith respect to domestic partners. These require-ments may apply to distributions of cash and proceedsfrom the sale, exchange, or other disposition of mem-bership interests held by domestic partners in thepartnership. If the domestic member fails to furnisha U.S. taxpayer identification number (typically byproviding a completed and executed IRS Form W-9)and certify that it is not subject to backup withhold-ing, or fails to otherwise comply with applicablebackup withholding exemption requirements, thepartnership and/or its agent, broker, or any payingagent may be required to apply backup withholdingto relevant payments to members. However, certaindomestic members that are U.S. persons (including,among others, corporations) are not affected by theserequirements. Because backup withholding is not anadditional tax, any amounts withheld under backupwithholding rules from payments to a domestic mem-ber may generally be claimed as credits against thatdomestic member’s U.S. federal income tax liability,provided that the required information is timely fur-nished to the IRS.13 See generally I.R.C. §6031, Treas. Reg. §1.6031(a)-1; see also I.R.C. §6698.14 See Temp. Treas. Reg. §1.6031(b)-1T; see alsoI.R.C. §6722.15 See Treas. Reg. §1.1441-5(b)(2)(i)(A).16 Foreign persons are subject to a taxation rate of 30percent on income received from U.S. sources that con-sist of interest, dividends, rents, premiums, annu-ities, compensation for services, or other fixed deter-minable annual or periodical gains, profits, or income.The rate is imposed on the gross amount and collectedthrough a withholding-at-source mechanism. SeeI.R.C. §§861(a), 871, 881, 864.17 The appropriate form of withholding documenta-tion depends on the foreign partner’s status. See gen-erally I.R.C. §§1441, 1442.18 See generally Treas. Reg. §§1.1441-1(e) and 1.1441-1(c), which describe the information that must beset forth in Form W-8 and provide guidelines fordetermining the validity and execution of the form.19 I.R.C. §1446(a).20 Taxable income, subject to certain adjustments, iseffectively connected with trade or business con-ducted within the United States.21 See Treas. Reg. §§1.1446-1 through 1.1446-6. Forthe highest applicable percentage rate for noncorpo-rate partners, see I.R.C. §1; for corporate partners,see I.R.C. §11(b)(1).22 See generally Treas. Reg. §§1.1446-3 and 1.6655-2.23 The foreign partner cannot rely on the LLC’s taxfilings. Instead, it must file its own tax returns (Form1040NR, Form 1065, Form 1120F, or other applic-able form) and timely pay the tax due.24 Amounts paid by the LLC as I.R.C. §1446 with-holding tax with respect to any foreign partner 1) arecreditable against that partner’s tax liability for the taxyear in which the LLC’s tax year ends, and 2) aretreated as distributed to that foreign partner by the part-nership. The foreign partner must file its own taxreturn (whether on Form 1040NR, Form 1065, orForm 1120F) and pay tax due.25 See Treas. Reg. §1.6011-4(b). If the partnershipparticipates in a reportable transaction, each memberof the partnership is treated as participating in thetransaction.26 Failure to disclose a reportable transaction incursa penalty under I.R.C. §6011, which ranges from$10,000 (noncorporate) to $50,000 (corporate)depending on the status of the offending taxpayer.27 See generally I.R.C. §871(a).28 See generally I.R.C. §11.29 See generally I.R.C. §§61 and 861(a). The divi-dends-received deduction, which reduces the effectiverate on dividends, is not available to foreign share-holders for dividends received from a corporateblocker. See generally I.R.C. §243.30 See I.R.C. §§861(a) and 871(a).31 See I.R.C. §1(h)(11)(B)(i), as amended by the 2003Jobs and Growth Act §302, Pub. L. No. 108-27(May 28, 2003). “Qualified dividend income” involvesdividends received during the tax year from domes-tic corporations and certain foreign corporationsdescribed under I.R.C. §1(h)(11)(C). Qualified divi-dends are taxed at the same rates applicable to net cap-ital gains. Qualified dividend income received bypartnerships is passed through to partners and taxedat the partner level at the 15 percent rate, providedthese dividends are received after December 31, 2002,and before December 31, 2010. See §102, Pub. L. No.109-222 (May 17, 2006) and §402, Pub. L. No. 108-311 (Oct. 4, 2004).32 For some foreign investors, it is not the 30 percentwithholding that generally reduces their rate of return.After all, they would be subject to the same 30 percentwithholding if they had invested directly in the LLCrather than through a corporate blocker. Rather, it isthe underlying corporate tax rate, applied at the cor-porate blocker level, that could potentially impactthe foreign investor’s rate of return unless managedeffectively.33 If the foreign investor does not expect to receive anydividends from the domestic corporate blocker, anopportunity exists to avoid the dividend withholdingtax under the applicable tax treaty. In these circum-stances, foreign investors would receive their returnof capital (and then some) invested in the corporateblocker through a sale of the blocker’s shares owned18 Los Angeles Lawyer July-August 2009
  • by the foreign investors. A sale of corporate shareswould result in capital gain, which generally wouldnot be subject to tax in the United States but in thecountry of residence of the foreign investors. See,e.g., United States-Italy Income and Capital TaxConvention art. 13(4) (entered into force Dec. 30,1985) (U.S.-Italy Tax Treaty).34 For example, dividends from the U.S. domesticcorporate blocker to a foreign shareholder who is anItalian resident would be subject to a withholding taxof 5 percent if certain conditions are met. See U.S.-ItalyTax Treaty art. 10(2)(a), supra note 33.35 See, e.g., Convention between the United States andthe Kingdom of the Netherlands for the Avoidance ofDouble Taxation and Prevention of Fiscal Evasionwith Respect to Taxes on Income art. 10 (Dec. 1992)(the U.S.-Netherlands Tax Treaty), which provides fora withholding tax on dividends at a rate of 15 percentand a reduced withholding tax rate of 5 percent ondividends paid from the United States to a resident ofthe Netherlands if the resident owns shares that rep-resent 10 percent or more of the voting power of theU.S. company paying the dividend. The withholdingrate is completely eliminated if the dividend is paid toa resident company that owns 80 percent or more ofthe voting power of the company declaring the divi-dend for the 12-month period ending on the datethe dividend is declared. Further restrictions on theability to claim the 0 percent withholding rate wereadded as art. 26 of the U.S.-Netherlands Tax Treaty,titled “Limitation of Benefits.” Article 26 contains cer-tain ownership and derivative benefits tests that wereformulated specifically to protect against treaty shop-ping and prevent certain taxpayers from reorganizingto become eligible for the elimination of withholdingtax on dividends. See art. 3 and art. 7 of the ProtocolAmending the U.S.-Netherlands Tax Treaty (Mar.2004) and the Department of the Treasury Expla-nation of the Protocol signed at Washington on Mar.8, 2004, Amending the U.S.-Netherlands Tax Treaty(2004). See also art. 28 of the Convention between theUnited States of America and the Federal Republic ofGermany for the Avoidance of Double Taxation withrespect to Taxes on Income and Capital and to CertainOther Taxes (Jan. 1990) and art. 21 of the Conventionbetween the Government of the United States ofAmerica and the Government of the Kingdom ofBelgium for the Avoidance of Double Taxation andthe Prevention of Fiscal Evasion with respect to Taxeson Income (Nov. 2006).36 The U.S. effective tax rate is currently 39.6%; com-pare the tax rate of other countries, such as Cyprus(10%), Hungary (20%), Ireland (12.50% excludingcapital gains), Switzerland (16.9% excluding capitalgains, which are taxed at 7.80%), the Netherlands(25.5%), Luxembourg (28.59%), and Belgium (33.99%).37 Tax haven jurisdictions include the Bahamas,Bermuda, British Virgin Islands, Cayman Islands,and the Isle of Man.38 See generally I.R.C. §881. The 30 percent with-holding rate may be further reduced by timely andappropriate invocation of the applicable tax treatybetween the United States and the foreign corporateblocker’s domicile. Note, however, that certain juris-dictions commonly referred to as tax havens do nothave any tax treaty with the United States.39 See generally I.R.C. §882.40 See generally I.R.C. §884.41 See I.R.C. §884(a), (d).42 Various U.S. tax antideferral mechanisms embed-ded in the Internal Revenue Code are triggered when10 percent or more of the foreign corporate blocker(or the foreign investor in the corporate blocker) isdirectly or indirectly owned by a U.S. person. See gen-erally I.R.C. §§954 (subpart F) and 1297 (PFIC).43 See note 35, supra.Los Angeles Lawyer July-August 2009 19tWitkin & Eisinger we specialize in the Non-JudicialForeclosure of obligations secured by real propertyor real and personal property (mixed collateral).When your client needs a foreclosure done profession-ally and at the lowest possible cost, please call us at:A“Industry Specialists For Over 22 Years”Incorporate inDelawareREGISTERED AGENTS SINCE 1978Delaware Corporation or LLCfiled in 24 hours.CREDIT CARDS ACCEPTEDGlobal Corporate Services, DELCORPThere is no substitute for experience.■■ Daily Journal Top Neutral 2008■■ Over 1,300 successful mediations■■ 15 years as a full-time mediator■■ 91% of Cases ResolvedLEE JAY BERMAN, Mediator213.383.0438 www.LeeJayBerman.comHOBSON DUNGOG LLPA new boutique law firm serving Northern and Southern California333 S. Grand Avenue | 25th Floor | Los Angeles, California 90071www.hobsondungog.comTEL 213.943.1307 | FAX 213.943.1301HOBSONDUNGOGJason A. Hobsonjhobson@hobsondungog.com310.948.9977Marsha-laine F. Dungogmdungog@hobsondungog.com989.859.8734■ Tax Credit Financing—Film, Renewable Energy, Low IncomeHousing, New Markets, and Historic Tax Credits■ Private Equity Real Estate and Corporate■ Affordable Housing and Community Development■ Tax Exempt Financing and Nonprofits