Taxation of Foreign Taxpayers<br />Presented by <br />Edward Umling, CPA, LLM<br />August 17 – 18,  2009<br />
General Overview<br />The United States asserts jurisdiction to tax income whenever it considers the income to be from sou...
Two types of income are subject to tax<br /><ul><li>Income Effectively Connected
Income Not ECI (i.e. FADP)</li></ul>Income Earned<br />Foreign Corporation<br /><br />from U.S. Sources<br />See II-1<br />
Fixed and Determinable Annual Period Income<br /><br />this term “is merely descriptive of the character or class of inco...
<br />If the transaction constitutes a sale or exchange, gain will not be taxable provided it is not effectively connecte...
How are the two types of income taxed<br />If its ECI its taxed at progressive rates<br />If its is FADP its taxed at a fl...
Exceptions<br />Interest on Bank deposits exempt<br />Interest on securities<br />Capital gains if they are not ECI<br />S...
Sales of U.S. Real Property<br />Nonresident alien individuals and foreign corporations are subject to tax on realized gai...
The Foreign Investment in Real Property Tax Act (FIRPTA)<br />The characterization of property as real property for purpos...
Foreign Investment in Real PropertyPolicy Overview<br />Before 1980 foreign investors realized gains on the sale of real p...
Example II-2<br />Foreign Company received<br />Royalties<br />Analysis<br />Represents “FADP” subject to 30% unless reduc...
Example II-2<br />Foreign Company received<br />Dividends<br />Analysis<br />Represents “FADP” subject to 30% unless reduc...
Example II-2<br />Foreign Company received<br />Interest<br />Analysis<br />Represents “FADP” subject to 30% unless reduce...
Example II-2<br />Foreign Company received<br />Royalties<br />Analysis<br />Represents “FADP” subject to 30% unless reduc...
“PE” Established<br />The Company send a salesman in the U.S. for two months and takes orders for 200 cars and title passe...
Analysis of Remaining Answer<br />Trading with the U.S. v. Trading “In” the (U.S. Article 5 ¶ 5 Determines Taxability)<br ...
Debrief<br />Income derived from U.S. sources is taxed at progressive rates<br />FADP is taxed at the lower of the treaty ...
Branch Profits Tax I.R.C. §884Policy Overview <br />Prior to the Tax Reform Act of 1986 (TRA), foreign corporations could ...
Policy Overview<br />A domestic subsidiary was subject to a 30% (or lower treaty rate) withholding tax on the remittance o...
Policy Overview<br />To eliminate the disparity, the TRA created Sec. 884, imposing the so-called branch profits tax (BPT)...
Policy Overview<br />To determine this amount, Sec. 884 looks to the &quot;U.S. net equity&quot; of the branch at the begi...
Earnings Stripping Rules Policy Overview Sec. 163(j)<br />Enacted by the Revenue Reconciliation Act of 1989, placed substa...
Earnings Stripping Rules Policy Overview Sec. 163(j)<br />These rules were enacted in response to what was perceived as an...
Earnings Stripping Rules Policy Overview Sec. 163(j)<br />These rules were enacted in response to what was perceived as an...
Example Overview<br />Needs 5M to capitalize<br />US Co<br />Debt or  Equity ?<br />
Example Overview<br />US Co<br />Equity 	     50,000<br />Debt 	4,950,000<br />Has the effect of reducing U.S. taxes for t...
163(j) Comes along and does two things<br />Disallows the U.S. companies excess interest expense as a current deduction wh...
Example II-8<br />Interest to UK				100,000<br />Unrelated				   60,000<br />160,000<br />Interest Income				70,000<br />I...
Example II-8<br />Interest Income				70,000<br />Interest Expense				90,000<br />Taxable Income				50,000<br />Add Back 		...
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Module 6 Taxation Of Foreign Taxpayers

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  • See II-1
  • See II-1
  • The characterization of property as real property for purposes of this source rule generally depends on local law. 267 The Foreign Investment in Real Property Tax Act (FIRPTA) provides an exception to this rule. For purposes of applying the source rule to property covered by FIRPTA, real property includes certain personal assets such as stock ownership, partnership interests, and other indirect interests in real property owned by foreign persons. 268
  • See II-9
  • See II-6
  • SeeII-7
  • 11-7
  • 11-7
  • Module 6 Taxation Of Foreign Taxpayers

    1. 1. Taxation of Foreign Taxpayers<br />Presented by <br />Edward Umling, CPA, LLM<br />August 17 – 18, 2009<br />
    2. 2. General Overview<br />The United States asserts jurisdiction to tax income whenever it considers the income to be from sources within the United States; (i.e., to have some nexus or connection with the United States that justifies taxation), <br /> even if the income is earned by a foreign corporation not subject to U.S. residence-based taxing jurisdiction. <br />See II-1<br />
    3. 3. Two types of income are subject to tax<br /><ul><li>Income Effectively Connected
    4. 4. Income Not ECI (i.e. FADP)</li></ul>Income Earned<br />Foreign Corporation<br /><br />from U.S. Sources<br />See II-1<br />
    5. 5. Fixed and Determinable Annual Period Income<br /><br />this term “is merely descriptive of the character or class of income,” whether or not paid in a lump sum, a statement inspired largely by the decision in CIR v. Wodehouse/<br />This is basically passive income (i.e. rents royalties, dividends and interest<br />
    6. 6. <br />If the transaction constitutes a sale or exchange, gain will not be taxable provided it is not effectively connected with a U.S. business.<br />
    7. 7. How are the two types of income taxed<br />If its ECI its taxed at progressive rates<br />If its is FADP its taxed at a flat 30% rate unless reduced by a treaty<br />
    8. 8. Exceptions<br />Interest on Bank deposits exempt<br />Interest on securities<br />Capital gains if they are not ECI<br />Sale or exchanges of 471 property (trading with the U.S. v. Trading in the U.S.)<br />See II-2<br />
    9. 9. Sales of U.S. Real Property<br />Nonresident alien individuals and foreign corporations are subject to tax on realized gain from the disposition of an interest in U.S. real property, held directly or indirectly. The gain is taxed as if it were effectively connected with the conduct of a U.S. trade or business, whether or not the foreign person is in fact engaged in a U.S. trade or business during the taxable year (§897)<br />
    10. 10. The Foreign Investment in Real Property Tax Act (FIRPTA)<br />The characterization of property as real property for purposes of this source rule generally depends on local law. FIRPTA provides an exception to this rule. For purposes of applying the source rule to property covered by FIRPTA, real property includes certain personal assets such as stock ownership, partnership interests, and other indirect interests in real property owned by foreign persons (§897(c))<br />See II-9<br />
    11. 11. Foreign Investment in Real PropertyPolicy Overview<br />Before 1980 foreign investors realized gains on the sale of real property tax free. <br />Congress responded by enacting Foreign Investment in Real Property Act (“FIRPA”)<br />This law basically treats gains realized on sales of real property located in the U.S. as ECI.<br />
    12. 12. Example II-2<br />Foreign Company received<br />Royalties<br />Analysis<br />Represents “FADP” subject to 30% unless reduced by treaty. Go to Article 12.<br />
    13. 13. Example II-2<br />Foreign Company received<br />Dividends<br />Analysis<br />Represents “FADP” subject to 30% unless reduced by treaty. Go to Article 10.<br />
    14. 14. Example II-2<br />Foreign Company received<br />Interest<br />Analysis<br />Represents “FADP” subject to 30% unless reduced by treaty. Go to Article 11.<br />
    15. 15. Example II-2<br />Foreign Company received<br />Royalties<br />Analysis<br />Represents “FADP” subject to 30% unless reduced by treaty. Go to Article 12.<br />
    16. 16. “PE” Established<br />The Company send a salesman in the U.S. for two months and takes orders for 200 cars and title passes in the U.S.<br />
    17. 17. Analysis of Remaining Answer<br />Trading with the U.S. v. Trading “In” the (U.S. Article 5 ¶ 5 Determines Taxability)<br />Title Passage Rule under 863(B). Income sourcing rules 1) Books of accounting method 2) IFP method 3) 50/50 method.<br />
    18. 18. Debrief<br />Income derived from U.S. sources is taxed at progressive rates<br />FADP is taxed at the lower of the treaty rate or 30%<br />Portfolio interest – exempt<br />Interest on securities exempt<br />Sale of 471 property exempt<br />Real Property – treated as ECI<br />
    19. 19.
    20. 20. Branch Profits Tax I.R.C. §884Policy Overview <br />Prior to the Tax Reform Act of 1986 (TRA), foreign corporations could face significantly different tax consequences on the distribution of U.S. profits.<br />See II-6<br />
    21. 21. Policy Overview<br />A domestic subsidiary was subject to a 30% (or lower treaty rate) withholding tax on the remittance of earnings to its parent.<br />By Contrast, Profits from a branch office, however, could be repatriated to the foreign home office without being subject to the additional withholding tax. <br />
    22. 22. Policy Overview<br />To eliminate the disparity, the TRA created Sec. 884, imposing the so-called branch profits tax (BPT). <br />Sec. 884 attempts to put a foreign branch operation on the same tax footing as a foreign subsidiary. This is accomplished by determining the amount of U.S. earnings theoretically &quot;repatriated&quot; to the foreign parent/shareholders by the branch.<br />See II-6<br />
    23. 23. Policy Overview<br />To determine this amount, Sec. 884 looks to the &quot;U.S. net equity&quot; of the branch at the beginning and end of the tax year. If this amount has decreased (and is not attributable to an operating loss), there is deemed to have been a repatriation of funds. <br />See II-6<br />
    24. 24. Earnings Stripping Rules Policy Overview Sec. 163(j)<br />Enacted by the Revenue Reconciliation Act of 1989, placed substantial restrictions on the amount of certain related-party interest expense deductions a foreign-owned U.S. corporation may take in computing its income tax (the so-called earnings stripping rules). <br />
    25. 25. Earnings Stripping Rules Policy Overview Sec. 163(j)<br />These rules were enacted in response to what was perceived as an erosion of the U.S. tax base through interest expense deductions. <br />The earnings stripping rules generally apply to a corporation with a debt-to-equity ratio in excess of 1.5 to 1;<br />
    26. 26. Earnings Stripping Rules Policy Overview Sec. 163(j)<br />These rules were enacted in response to what was perceived as an erosion of the U.S. tax base through interest expense deductions. <br />The earnings stripping rules generally apply to a corporation with a debt-to-equity ratio in excess of 1.5 to 1;<br />See II-7<br />
    27. 27. Example Overview<br />Needs 5M to capitalize<br />US Co<br />Debt or Equity ?<br />
    28. 28. Example Overview<br />US Co<br />Equity 50,000<br />Debt 4,950,000<br />Has the effect of reducing U.S. taxes for the interest expense deduction. Moreover the payment to the parent usually had nil withholding. <br />
    29. 29. 163(j) Comes along and does two things<br />Disallows the U.S. companies excess interest expense as a current deduction where the interest is paid to a related person<br />Requires a minimum capital structure of debt to equity<br />Excess interest – interest that exceeds 50% of taxable income<br />
    30. 30. Example II-8<br />Interest to UK 100,000<br />Unrelated 60,000<br />160,000<br />Interest Income 70,000<br />Interest Expense 90,000<br />Taxable Income 50,000<br />Add Back 90,000<br />Adjusted Taxable Income 140,000<br />
    31. 31. Example II-8<br />Interest Income 70,000<br />Interest Expense 90,000<br />Taxable Income 50,000<br />Add Back 90,000<br />Adjusted Taxable Income 140,000<br /> 70,000<br /> 90,000<br />50%<br /> 20,000<br />

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