Presentation: International Income Taxation Chapter 4 ... Chihuahua Gas p. 234 881(a) as Basis for Decision Rent not paid by a Mexican corporation (HIDRO) ETBUS to related Mexican

International Income Taxation Chapter 4: FOREIGN PERSON’S NONBUSINESS US SOURCE INCOME Professors Wells

Presentation:

February 5, 2018

2

Foreign Persons: Nonbusiness U.S. Source Income – Ch. 4

Code §871 (a) & §881(a) – concerning the 30% gross tax on fixed or determinable annual or periodic income (FDAP). But, FDAP can be “effectively connected” with a U.S. trade or business and then be taxed on a net income basis. §864(c)(2). Possible modification of the applicable (gross withholding) tax rates by (1) a Code section or (2) a bilateral U.S. income tax treaty.

M (Foreign Corp)

US ToB/ECI US P.E./Bus. Profits

Active: “Net Basis Tax” (with Branch Profits Tax) Chapter 3

Passive Investor: Withholding Chapter 4

“Fixed Determinable

Annual Periodical”

3

Why impose tax on a gross basis? P. 229

Flat tax on a gross income facilitates collection at source without a taxpayer filing an income tax return.

Limited potential to collect in foreign place.

Gross income and net income are approximately the same amount in many situations involving investment income (i.e., no significant expenses are incurred to generate the investment income).

Is 30% the appropriate tax rate? Cf., corporate tax rate of 35%.

M (Foreign Corp)

Passive Investor: Withholding



30% or

Treaty Rate

4

What is “FDAP Income”? p. 230

Interest, dividends, rents and royalties and other fixed or determinable annual or periodic “gains, profits and income”. Code §871(a)(1)(A) & §881(a)(1). Consider other income sources: annuities, retirement plan distributions, alimony.

M (Foreign Corp)

Passive Investor: Withholding



30% or

Treaty Rate

Section 871(m) (p.234) was enacted to prevent foreign investors from avoiding U.S. withholding tax on dividends by recharacterizing them through the use of derivative or similar contracts. Via Treas. Reg. §§ 1.871-7(b)(2), 1.881-2(b)(2), the IRS subjects substitute payments under securities lending arrangements to withholding as interest.

Wodehouse Case p. 231 One Payment Disposition

5"

Wodehouse Case p. 231 One Payment Disposition

Lump sum amount was received for an exclusive book right in the United States. Sale of the property interest in a copyright. Held: one lump sum amount (not contingent) represented the acceleration of all the royalties and, therefore, FDAP. Do not need multiple payments to have “annual or periodic” payments.

Lump sum amount was received for an exclusive book right in the United States. Sale of the property interest in a copyright. Held: one lump sum amount (not contingent) represented the acceleration of all the royalties and, therefore, FDAP. Do not need multiple payments to have “annual or periodic” payments.

6

FDAP Income Additional Examples p. 232

1)  Rental income gross-up for expenses or real estate taxes paid by tenant – Rev. Rul. 73-522

2)  Annuity payments from a U.S. insurer. Rev. Rul. 2004-75. Treated as having a U.S. source even though sold by a foreign

Lessor (Foreign Corp)

County Property Assessor

Rent US-Owned Parent

Extra Rent

branch in a foreign country. Cf., branch bank sourcing rules. 3)  §871(m) treats “dividend equivalent amounts” as FDAP subject to

withholding. A dividend equivalent amount includes payments under a securities lending or repo transaction, payments under an NPC, and other similar arrangements. New 2013 regulations provide complex rules on how much investment return correlation is needed for a contractual return to be considered a dividend equivalent amount.

Rev. Rul. 73-522 Illustration

7

Chihuahua Gas p. 234 §881(a) as Basis for Decision

Rent not paid by a Mexican corporation (HIDRO) ETBUS to related Mexican corporation (Gas) for U.S. use of trucks. Tax liability results from a Code §482 adjustment. No payments had been made from which the tax could be withheld. Tax obligation of the recipient of the imputed rent exists under §881. Must an actual payment be made to trigger (1) §881(a) & (2) withholding at source?

Chihuahua Gas Corporation

Hidro Corporation

US Tractor Fleed

US Office

RentFree

8

U.S. Source Interest & Tax Exemptions p. 238

1)  Bank (and S&L) account interest: Code §§871(i)(2)(A) & 881(d)

2)  Portfolio debt investment interest:

Code §§871(h) & 881(c) “Bearer” form no longer permitted to qualify for portfolio interest

exception. Bond must be in registered form. Note the carve-out from the portfolio interest exception for bonds

held by 10%+ owners or for contingent interest. What is the impact of these exemption provisions on the U.S.

capital markets?

3)  However, no exception for 80/20 companies any longer (p.240)

9

Dividends from a U.S. Corporation p. 240

1)  Dividends from a U.S. corporation. Code §861(a)(2)(A) – sourcing

•  Limited Grandfather Rule for “Existing 80/20 Companies.” 80/20

Company is a US Corp. formed before January 1, 2011 and 80%+ foreign source income: No exception for new companies but a grandfathering for pre-2011 companies if business has not changed. Code §871(i)(2)(B) – untaxed proportion based on foreign percentage. Cf., interest rule: a sourcing rule

2) Foreign corp. with U.S. source dividends. The branch profits tax rule

eliminates the tax liability on dividend.

10

Wagering Income p. 241

1)  Las Vegas gambling – Code §871(j)

2)  Horse & dog racing – Code §872(b)(5)

3)  Lottery winnings?

How prove net gambling winnings? Any offset for invested funds/tax basis? Any offset for gambling losses? Note §165(d) – losses allowed to extent of gains. Withholding at source?

11

Impact of Income Tax Treaty Provisions p. 242

Tax treaty reduction – withholding rates: Dividends: 15%; but, 5% for certain corps. (Note: recent U.S. treaties – zero withholding tax for payments from subsidiaries) Interest: -0- Royalties: -0- (cross-licensing – next slide) Pensions, annuities and alimony payments: -0- Annuity defined – see Abeid case, p. 243

12

Royalty Withholding and Cross Licensing

Rev. Proc. 2007-23 – cross-licensing – two parties grant licenses to each other. Withholding obligation on gross value? Net? Rev. Proc. 2007-23 states:

(1)  No §1001 gain (or loss) when mutual gains of licenses.

(2)  “Net consideration” to be taken into account for (withholding) tax purposes – assuming a “qualified patent cross licensing arrangement” (QPCLA).

(3)  Financial statement conformity (i.e., “booking”) requirement.

13

“Treaty Shopping” – Funds Inbound into the U.S. p. 244

Historical background: (1) Netherlands Antilles finance sub created by (2) U.S. corp. Purpose: To facilitate borrowing arrangements through Antilles and utilize the U.S. income tax treaty exemption on interest expense paid to the N.A. lender. This income tax treat functioned as a “treaty with the world”. Why?

14

Aiken Industries Conduit Arrangement

Transaction Steps: 1)   MPI borrows from ECL.

2)   ECL sells MPI note to Industrias (in exchange for Industrias notes).

3)   MPI pays interest to Industrias. Note: Honduras – U.S. income tax treaty exempts interest from source taxation.

4)   Industrias pays interest to ECL Valid business purpose?

ECL

CCN

Aiken Industries

MPI

Industrias

1 2

3

4

15

Rev. Rul. 84-152 (now obsolete)

Swiss parent with U.S. operating sub and Netherlands Antilles financing sub (brother-sister subsidiaries). 1.  P provides funds to S at 10% interest rate

2.  Antilles sub loans funds to U.S. brother-sister at an 11% interest rate, funds sourced from Swiss parent. Conduit analysis – U.S. to Antilles to Switzerland. Antilles entity was not recognized. Tax under the Swiss treaty? Is “derivative benefits” concept applicable?

P Switzerland

S Antilles

R United States

1

2

16

Northern Indiana Public Service p. 253

Borrowing by N.A. subsidiary of U.S. parent corporation to exploit the N.A. – U.S. income tax treaty interest exemption. Tax Court decision: Finance subsidiary is recognized as the borrower. Treated as adequately capitalized. What debt-equity ratio is necessary to recognize finance subsidiary transaction? Other suggestions?

17

Limitations on “Treaty Shopping” – Treaty & Code p.255

1)  Treaty Shopping – Article 22.

2)  Anti-conduit regulations – Code §7701(1) – conduit entities are disregarded. p. 231. Regs. §1.881-3 & 4. Disregard a conduit?

Does the conduit perform significant financing activities? Is a tax “treaty override” occurring here? p. 233

18

Limitations on “Treaty Shopping” – Treaty & Code p.255 Ingersoll-Rand v. Commissioner, T.C. Dkt. No. 025769-13

I-R Company (Delaware)

I-R Company Ltd. (Bermuda)

I-R (Barbados) Hldgs (Barbados)

Global Hldg. (Bermuda)

IRCO Note $3.6 billion / 11%)

IRCO Note 1

2

Interest (5% treaty rate wht)

3

3

Loan

Ontario 3 (Hungary)

3

I-R (Luxembourg) S.a.r.l. (Luxembourg)

Lux Note 2

Loan

2

Interest

(0% treaty rate wht)

3 3

December 29, 2015: Court order issued that IRS and Ingersoll-Rand agreed to an $86 million withholding tax assessment

19

Hybrid Entities Cross Border Arbitrage p. 257 Pre-§894(c) Idea for Homeless Income

NA General Partnership, et al. v. Commissioner, TC Memo 2012-172 (Scottish Power)*

U.S. Tax Consolidation

ReverseHybridEn:ty

* Note: Tax years predated Section 894(c) proposed regulations targeting this structure

Target United States

Parent (U.K.)

Subsidiary/Partnership United States

$932million(CashDividend)

20

Foreign (forward) hybrid entity: Corporation in the foreign country but partnership (conduit) status in the U.S. Reverse hybrid entity: Corporation for U.S. tax purposes but flow-through entity status for foreign tax purposes.

P Switzerland

R United States

1

Question: does the US-Netherlands, US-Switzerland or no treaty apply?

P Switzerland

S Netherlands

R United States

2

R United States

P Switzerland

3

S United States

Dividend

Interest

Div

iden

d

Hybrid

Reverse Hybrid

§894(c) limits treaty benefits and denies deductibility in the NA General Partnership fact pattern (i.e., deductible interest in that fact patterns becomes dividend [to extent of amount of dividend to reverse hybrid] for all tax purposes).

S Netherlands

Hybrid Entities Cross Border Arbitrage p. 257 Response #1: §894(c)

Consistent with OECD Multilateral Agreement Article 3.

21

NA General Partnership, et al. v. Commissioner, TC Memo 2012-172 (Scottish Power)*

U.S. Tax Consolidation

ReverseHybridEn:ty

* Note: Tax years predated Section 894(c) proposed regulations targeting this structure

Target United States

Parent (U.K.)

Subsidiary/Partnership United States

$932million(CashDividend)

Hybrid Entities Cross Border Arbitrage p. 257 Response #2: §267A

267A denies a deduction for disqualified related party amount attributable to a hybrid transaction by hybrid entity. Disqualified related party amount is defined as interest or royalty to the extent such amount is not included in the income (or a fictional deduction provided against this income inclusion) in the related party’s foreign jurisdiction. Hybrid Transaction: Inconsistent treatment of payment. Hybrid Entity: Entity is fiscally transparent

in one jurisdiction but not so in the other.

22

Treaty Shopping p. 259 Problem 1

Investors own ILL (Swedish corp.) ILL organized in a jurisdiction (Sweden) where all its shareholders reside. Article 11 of the income tax treaty exempts the interest payments from tax withholding at source. No “treaty shopping” here – all ILL owners are Swedish residents (and not U.S. persons).

AmFish (US Corporation)

ILL (Sweden)

Johnson Olson

23

Problem 2: Substantial Presence Test? p. 260

2006 Treaty Art. 22 (2)(e) – 50% rule. (i)  At least 50% is owned by a

resident for at least ½ of the days of the year; and

(ii)  Less than 50% of the gross income is paid directly or indirectly to nonresidents of the two treaty countries in a deductible form, i.e., the “base erosion test” is not applicable.


ILL (Sweden)

Johnson Olson

24

Problem 3 p. 260 2006 Treaty Article 22(2)(e) and (3)

Sale of all stock (when?) to a corp. located in 3rd country (Brazil – no tax treaty). Treaty benefits are probably jeopardized; but, what if 50 percent of stock of Superrich stock is traded on a U.S. stock exchange or in Sweden? No protection. Or, an active trade or business in Sweden – Article 22(3).


ILL (Sweden)

Superrich Corp (Brazil)

25

Problem 4 ILL Shares Listed on an Exchange p.260

Treaty article 22(2)(c)(i) & 22(5)(a)). Treaty benefits are preserved if all ILL shares are trading on the Swedish stock exchange (one of the tax treaty partner countries). Why preserve tax treaty benefits here?


ILL (Sweden)

Public (Swedish Exchange)

26

Problem 5 p.260 ILL Shares Traded & Sold

Shares listed and 75 percent of shares sold mostly to non-treaty country residents. Art. 22(2)(c)(i). Treaty benefits preserved if 75 percent of shares trading on Sweden exchange? Not all shares (of class) must be listed. Therefore, must Art. 22(2)(e) test be satisfied? Percent owned by Swedish?


ILL (Sweden)

Public (Swedish Exchange)

27

Problem 6 p.260 Shares Are Sold Directly to 3rd Country

75 percent of the ILL shares are sold directly to non-treaty country residents and not publicly listed. Article 22 will deny treaty benefits to ILL. Why deny the tax treaty benefit when the shares are not publicly traded?


ILL (Sweden)

Johnson Brazilian S/H

75% 25%

28

Problem 7 p. 260 The “Base Erosion” Test

Loan from bank in Norway to Partsub in Sweden and then loan to parent in U.S. Partsub being used as a financing subsidiary, although already an operational(?) sub. Article 22(3) (which preserves a tax treaty benefits in certain trade or business situations) will probably not protect Partsub since no relationship between the lending transaction & trade or business in Sweden.

AmCorp (US Corporation)

PartSup (Sweden)

Norwegian Bank Loan

Loan Interest

29

Problem 8 p. 260 Base Erosion Test

Loan from bank in Norway to sub in Sweden to parent in U.S. Amcar (Parent corp.) guarantees the loan to Partsub. Even if OK under the treaty (Art. 22(3)), note that the guarantee of the loan by Amcar would trigger the application of the anti-conduit rules. See Reg. §1.881-3(c)(2).


PartSup (Sweden)

Norwegian Bank Loan

Loan Interest

30

Problem 9 p. 260 Base Erosion Test

Loan from (1) bank in Norway to sub in Sweden (2) to parent in U.S. Partsub organized shortly before the loan agreements were concluded. Anti-conduit rules would almost certainly apply. Reg. §1.881-3(a)(4) factors appear to be present. Objective of the intermediary is to reduce U.S. income tax.


PartSup (Sweden)

Norwegian Bank Loan

Loan Interest

31

Capital Gains p. 260 Source to the Residence

Capital gains are not treated as effectively connected with a trade or business. See U.S. Model Tax Treaty, Article 13(6). Code §865(a) – source of capital gains from sale or exchange of personal property is at the residence of the taxpayer. Therefore, foreign income for a foreign taxpayer. Cf., intellectual property transactions. Sale; contingent payments effect – as royalty?

32

Withholding at Source Mechanisms p. 262

Code §§1441 & 1442 – Withholding at source at 30% rate on FDAP income. No withholding requirements for ECI – ETBUS income. Code §§1441(c) & 1442(b). Documentation provided to the payor: IRS Form W-8ECI (formerly IRS Form 4224).

33

What Amount is Subject to Withholding? p. 262

Consider Rev. Rul. 72-87 Concerning corporate E&P calculation. Must payor assume the existence of adequate E&P for dividend characterization. Obsolete by Reg. §1.1441-3(c)(2)(i). Consider other situations where recovery of tax basis (i.e., basis is not gross income). What if a nontaxable stock dividend? §305.

34

Cascading Royalties p. 263 Foreign Withholding Agent

Rev. Rul. 80-362 – licensing arrangements re U.S. patent: A foreign country – license to X

(no income tax treaty with U.S.) X Netherlands corporation

(Dutch – U.S. treaty) – sublicense Y U.S. Corporation Royalties from X to A are not exempt.

A Non-Treaty

X Netherlands

Y United States

License US IP

Sub- License US IP

Royalty Royalty

35

SDI Netherlands p. 265 Withholding Agent Issue

Facts: 1.  SDI Bermuda licenses to SDI Netherlands 2.  SDI Netherlands which licenses to SDI USA.

Why a Dutch intermediary?

Issue: Netherlands to Bermuda royalty payment as U.S. sourced and subject to U.S. gross withholding at source? Held: No.

No conduit argument by IRS.

The SDI Bermuda deal was separate.

SDI Bermuda

SDI Netherlands

SDI United States

License Global IP

Sub- License US IP

Royalty Royalty

36

Withholding Agent Responsibilities p. 270

Who is the withholding agent? How does one know whether the payee is domestic or foreign? IRS Form W-9. Possible exception in ECI & USTB, with representation from recipient. Use an alternative approach: obtain certification from the home country re tax status as being a resident in other country? Refund procedure, after status documented?

37

Withholding for Compensation Income p. 272

Normal wage withholding, rather than 30 percent flat rate, for employee. Rev. Rul. 70-543, p. 248, involving self-employed individuals and horse racing operator. 30% gross withholding at source required for fighter and golfer, but not for horse racing operation (if prior IRS Form 4224 provided, now IRS From W-8ECI).

38

Partnerships & Withholding at Source p. 275

Code §1446. The partnership must withhold an amount equal to: (1) the allocable share of partnership income, times (2) the maximum marginal income tax rate. Any actual distribution is not relevant for this purpose. Note similarity to the branch tax. The withheld amount will not equal the amount of the net income tax liability. Consequently, an income tax return is required of the partner.

39

Proposed (2010) Additional Withholding Tax Regime p.276

Proposed Chapter 4, Code §§1471-1474. Proposed “Foreign Account Tax Compliance Act” (FATCA), in Tax Extenders Act of 2009, H.R. 4213. To impose a 30% withholding tax at source unless foreign recipient (bank or other) certifies no substantial U.S. owners. To be a “filter” for Chapter 3 withholding.

40

Taxation of U.S. Real Property Gains (FIRPTA) p. 277

Code §897 – gain on U.S. real property sale treated as ECI of USTB . What is the definition of a “U.S. real property interest” for this purpose? Real property interests, mines, wells, and “associated personal property”. Leasehold interests; options to purchase. What is the reason for this special tax regime pertinent to real property?

41

Further Definition of U.S. Real Property Interest p. 279

Consider: (1)  Loans, but an “equity kicker” loan?

(2)  Sale of stock of a “United States real property holding corporation” (all gain subject to tax, not only the U.S. %). Not including publicly traded stock (except for 5%+ shareholder).

42

Definition of U.S. Real Property Holding Corp.

Holds U.S. real property greater than 50% of both (1) real property and (2) trade or business assets of the corporation. Note: comparative asset values (and currency fluctuations) could cause constant changing of above or below the 50% level. Why exclude liquid assets from this calculation? An “anti-stuffing rule”?

US RP Holding Company


Foreign Shareholder

Buyer

43

Treatment of the Foreign Corporation – Special Rules p.281

1)  Sale of Shares of foreign corporation; but liquidation & redemption distribution?

2)  Distribution by foreign corporation of its appreciated U.S. real property triggers gain recognition. Code §897(d)(1).

3)  Possible applicability of tax non-recognition provisions. E.g., Rev. Rul. 84-160 & Code §351 dropdown of assets into a U.S. holding corp. Code §897(e).

44

Code §1445 FIRPTA p.284 Withholding at Source

Transferee must withhold 10 15 percent of the gross amount realized from the disposition transaction. The real “final tax”? Applies to the proceeds (including debt) and not to the gain realized from the real estate sales transaction. U.S. income tax return is required from the seller (to determine net gain/loss). Cf., possible information reporting.



Foreign Shareholder

Buyer

45

Code §1445 Exceptions to FIRPTA p.285 Withholding at Source

Exceptions to the withholding requirements – Code §1445(b): 1)  Not a foreign seller, e.g., U.S. individual.

2)  Corporation not a USRPHCo. How prove this status?

3)  IRS “qualifying statement” received.

4)  Future use for certain residence purposes.

5)  Regularly traded shares (+/- 5%).

46

Code §1445 & Entity Distributions p. 286

Foreign corporate distributions – withhold 35% of the gain (or 20 percent if provided per regulations). Tax applies to the corporation which knows its tax basis for distributed asset. §1445(e)(2). U.S. corp.? 10% on liquidation distributions. Partnership & trust distributions – Withhold 35% of the gain realized to extent allocable to a foreign partner/foreign trust beneficiary. §1445(e)(1).


Foreign Shareholder

Stock Cash

47

FIRPTA & Tax Treaties p. 287

Is any FIRPTA tax immunity provided under an applicable U.S. bilateral income tax treaty? No. See U.S. Model Treaty, Article 13, re jurisdiction to tax real estate income – including disposition gain – in the country of situs (including the stock of a USRPHCo.).

48

FIRPTA and REITS

Add Role of REITS

49

US Domestic Subsidiary

Foreign-Owned Parent

Third Country Operations

US-Owned Parent


Third County Operations

Foreign Holding Company

Foreign-Owned US-Owned

Current Reality: Residence Choice is Often a Territorial Jurisdiction

Residual Profits

Residual Profits

Res

idua

l P

rofi

ts

1920s Mercantile Structure

ImperialCo (England)

Colony Co (India)

•  Supply Chain Transaction •  Lease Stripping Transaction •  Interest Stripping Transaction •  Royalty Stripping Transaction •  Service Stripping Transaction

TP: Cost + x%

R E S I D U A L

International Policy Challenge: Base Erosion and Profit Shifting

TP: Cost + x%

TP: Cost + x%

Tax Base Erosion and Homeless Income: Collection at Source is the Linchpin,” 65 TAX L. REV. 535 (2012)

50

Base Erosion and Profit Shifting: Financing the US Enterprise p. 287

Foreign party capitalizes the U.S. subsidiary with both (1) debt and (2) equity. Dividends subject to possible withholding at source; not deductible by the payor corp. Interest is deductible (subject to §163(j)) and not subject to outbound withholding (under most bilateral treaties). What is “debt” as contrasted with “equity”? See Code §385.

Foreign Parent

US Subsidiary

Interest vs.

Dividends

Base Erosion: Interest Stripping

51

High Profile Re-Leveraging Transactions

GlaxoSmithKline Tyco

GSK Investment (Switzerland)

GSK Americas (US)

Tyco Int’l (Switzerland)

Tyco Electronics Corp (US)

$13.5 Billion Intercompany Debt Tax Deficient of $864 million (2001-2003) Additional Exposure of $1.06 billion (2004-2008)

Interest: $2.8 billion (tax of $883 million) (add’l $6.6 billion of interest in later years)

Foreign Owned MNE Structure Inverted MNE Structure

IRS Conceded Case Before Trial Outcome: Tyco settled for ~$220 million with another $250 million in later years.

Base Erosion and Profit Shifting: First Battlefield: Is Interest “Excessive” p. 288

52

Base Erosion and Profit Shifting: First Responder: Section 163(j) p. 288

“Earnings-stripping” §163(j): business interest paid to related party.

Postpones deduction for “disqualified interest”. 163(j) limit: business interest income + 30% ATI + floor plan financing interest

What is “business interest”?

Foreign Parent

US Subsidiary

Interest Deduction Reduces US Tax Base

Base Erosion Defense: §163(j) Earnings Stripping Rules

Interest Income is Low-Taxed in foreign Country

Answer: Business interest does not include interest from trade or business as employee, interest related to electing real property business, electing farm business interest, interest related to furnishing electrical energy, water, or sewage or gas or steam or transportation of gas or steam by pipeline. Small Business Exception: 3-year average gross receipts < $25 million.

53

Base Erosion and Profit Shifting: First Responder: Section 163(j) p. 288

§163(j) is applicable to all taxpayers regardless of form (special rules apply for partnerships and S Corporations) and regardless of whether interest is paid to related or unrelated parties. Small Business Exception for businesses with 3-year average gross receipts < $25 million.

Business Interest Carve-Outs:

Foreign Parent

US Subsidiary

Interest Deduction Reduces US Tax Base


Interest Income is Low-Taxed in foreign Country

interest from trade or business as an employee, interest related Answer: Business interest does not include

to electing real property business, electing farm business interest, interest related to furnishing electrical energy, water, or sewage or gas or steam or transportation of gas or steam by pipeline.

54

Base Erosion and Profit Shifting: Treatment of Unrelated Party Debt? p. 289

Business interest includes debt from unrelated party loans. Old law restricted this to only unrelated party debt guaranteed by the parent company, but now it includes all debt.

Foreign Parent

US Subsidiary Interest Last Bank

Standing


55




Foreign-Owned

Residual Profits

Base Erosion and Profit Shifting: Second Response: Base Erosion Alternative Tax

TP: Cost + x%

§59A enacts the “BEAT.”

Tax on excess of modified taxable income over regular taxable income. (5% in 2018, 10% in 2019-2025, 12.5% after 2025).

Modified taxable income is computed without benefit of “base erosion payments.”

Base erosion payments are deductible payments to a related foreign person that

results in a US tax deduction. But, a base erosion payment does not include a deduction for cost of goods sold except where foreign person is a surrogate foreign corporation (or related foreign person of a surrogate foreign corporation). Scope Limitation: Only applies to corporations with $500 million of gross receipts. Does not apply if full US withholding or net basis taxation applied to foreign recipient. Cost only services excluded.

56




Foreign-Owned

Residual Profits

Base Erosion and Profit Shifting: Second Response: Base Erosion Alternative Tax

TP: Cost + x%

Modified Taxable Income is reduced only by credits allowed under §38* not to exceed 80% of the lesser of such credits or the base erosion minimum tax amount (determined without taking into account §38 credits). Applicable Taxpayers are corporations other than a RIC, REIT, or S Corporation with average annual gross receipts (over 3 year

period of > $500 million and with a base erosion percentage of at least 3% (2% for certain financial institutions).

* §38 Credits: low-income housing credit, renewable electricity production credit, and energy credits

Final Thoughts: No carryforward mechanism. NO exception for payments to US branches. Also keeps track of base erosion payments that create NOLs.

57

Problem 1 p. 292 Securities Income & Trading

NRA has U.S. securities transactions. Dividends of $30,000 from shares and $200,000 gains and $100,000 losses; total net income of $130,000. Not ETBUS - §864(b)(2)(A)(i). Capital gains not taxable in the U.S. Dividends subject to U.S. tax in U.S., so $9,000 tax on $30,000 of dividends (30% tax rate, unless 15% rate under a treaty).

58

Problem 2 p. 292 Excess Capital Loss

NRA has $200,000 gains and $230,000 losses; net capital loss of $30,000. Dividend income of $30,000. Loss of $30,000 is not available to offset the tax on the $30,000 of dividend income (unless ECI & ETBUS). Withholding tax imposed at source on the dividends.

59

Problem 3 p. 292 Discretionary Authority

Discretionary authority to buy and sell to be granted to broker. NRA will not be treated as ETBUS. Code §864(b)(2) safe harbor provision will continue to apply to the NRA.

60

Problem 4 p. 292 §864(b)(2)(B) Safe Harbor

Foreign commodities dealer takes title to wheat in U.S. and the wheat is then sold to the Government of India FOB NYC. Income from this sale is not FDAP and, arguably, dealer is not ETBUS (since only sporadic U.S. transactions) and, therefore, no U.S. tax liability even though U.S. source income under the title passage test. No P.E. if an income tax treaty is applicable. Events are solely in the U.S., but no U.S. tax.

61

Problem 5 p. 292 Cf., Balanovski Scenario

Foreign sales reps send orders to purchasing agents in the U.S. and goods are purchased in the name of foreign corporation. Orders are accepted in the foreign country. Title transferred at port of destination. Customers pay transit insurance. Not a USTB or P.E.? If so, what income source (U.S. for foreign)?

Bolanovski Horenstein

CADIC (Argentina)

62

Problem 6 p. 293 Related U.S. & Foreign Parties

Foreign corp. sells machinery parts throughout Europe. Bought parts from a related company in the U.S. and took title to the parts in U.S. and delivered the parts to Europe. Foreign corp. receives foreign source income from the sale of inventory. U.S. tax? No. And, no imputed U.S. status because the transaction is between related companies.

Colonial (US Corporation)

Empire (German)

Holdco (Swiss)

Sale

Sale

European Customers

63

Problem 7 p. 293 Foreign Corp - Services

Parts are delivered to customers at the U.S. factory and customers pay all shipping costs. Foreign sub receives a 20 percent commission from the U.S. Empire receives services income and services income is sourced where those services are rendered. Presumably, those services are performed outside the United States.

Colonial (US Corporation)

Empire (German)

Holdco (Swiss)

Commission

European Customers

64

Problem 8 p. 293 Royalties or Compensation?

Soprano from France made record in L.A.; similar to the Boulez case? Receives 10 percent of gross revenue from worldwide sales, described as ‘royalties” under the contract between her and the U.S. recording company. 1)  Copyright (royalty) or compensation?

2)  Cf., tax treaty treatment: compensation (taxable) or royalty (exempt)? See Art. 17.

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Problem 9 p. 293 Community Income

U.S. citizen moved from U.S. to Peru as employee of sub of U.S. shipping co. Married Peru citizen/resident. Peru – community property jurisdiction. Code §879 says community earnings belong to the working spouse. Result: All his income (§911 exclusion?)

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Problem 10 p. 293 Outbound Alimony & Interest

Employee returns to U.S. without NRA wife and she is an ex-wife. He transmits alimony (U.S. source) and child support (not income) to Peru. Also, he pays (U.S. source) interest to Peru bank on his personal loan. Interest payment subject to 30% U.S. tax withholding at source (tax treaty?).

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Problem 11 p. 294 Partnership Services §1446

NRA partner in U.S. partnership with USTB. Equal share in profits and losses. NRA works in Ireland. To what extent are services provided in the U.S.? U.S. source income if U.S. based services but not if foreign provided services. Transform the NRA into an employee? Include a “special allocation” provision in the partnership agreement?

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Problem 12 p. 294 U.S. Land Ownership USTB?

ETBUS? If not ETBUS, 30% withholding at source on the $100,000(?) annual rental income, plus any real estate taxes paid by the tenant. No deductions for expenses. Therefore, elect Code §871(d) treatment. Then taxable on Code §1 progressive rates on the net income of each. U.S. Model Treaty – Article 6(5).

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Problem 13 p. 294 Sale of U.S. Land & FIRPTA

NRA sale of U.S. land (i.e., real property). U.S. income tax treatment of the profit? Yes, §897 imposes tax – FIRPTA rules. §1445 imposes a withholding obligation at source on the payor. U.S. Model Income Tax Treaty, Article 13(1), confirms that U.S. jurisdiction exists to tax these real property gains.

Leonardo &

Verdi

US Real Estate

US Buyer

Purchase Price Less 15% Withholding

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Problem 14 p. 294 USRPHCo Status? 50%+ Test

NRA invested in wholly owned U.S. corporation: 1)  NYC apartment for $2 million

2)  Stock (publicly traded): $2 million

3)  Art Gallery: $2 million (rented space; annual lease & no renewal right)

Consider (for FIRPTA purposes) the various alternatives concerning the relative fair market values of the several properties.

Romano

Knickerbocker (US Corporation)

Stock

Issue: Did USRPI > 50% of value in last 5 years?

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Problem 15 p. 295 Foreign Corp. Stock Sale

NRA invested in wholly owned foreign corporation. The interest in a foreign corporation is not a U.S. real property interest. Sale of this stock would not be taxed under FIRPTA, but the stock value to be paid should be reduced by the purchaser by the embedded potential internal federal income tax liability.

Romano

Knickerbocker (Cayman Corp.)

Stock

Issue: Did USRPI > 50% of value in last 5 years?

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Problem 16 p. 295 Indirect U.S. Ownership

Status of Bluewater as a USRPHCo.?

Yes, became a USRPHCo. when acquiring shares of foreign corp. (Paradise) with U.S. real property (even though U.S. assets had a low tax basis). 40 U.S. and 30 foreign.

See Code §897(c)(5).

The sale of Bluewater shares by Casino (NRA) for 1 million profit results in FIRPTA gain and U.S. tax to Casino.

The “less than 5% rule” is not applicable.

Casino

Blue Water (US Corporation)

Issue: Look-through Paradise and Determine relative value of real property.

Caribbean Hotels

Paradise (Bahamas Corp.)

Florida Hotels

Public

sale

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Problem 17 p. 295 Disqualified Interest & §163(j)

New §163(j) now allows only 30% of ATI. ATI is $500,000 (regular taxable income $200 + interest expense of $280,000 and $20,000 depreciation). So, the interest expense is limited is limited to $150,000 with regular taxable income of $330,00 ($500-$20-$150). Section 59A does not apply as modified taxable income of $480,000 (regular taxable income of $330,000 plus base erosion payment of $150,000) x 10% is less than $330,000 x 21%.

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Problem 18 p. 295

Does failure to tax internet profits create an unacceptable advantage for electronic commerce taxpayers over “bricks and mortar” taxpayers? Note: 2009 commentary on this subject by some CEOs of “bricks and mortar” companies.

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Problem 1 p. 296 Tax Planning

Panco to acquire U.S. real property & stocks and bonds of U.S. real estate companies. 1)  Current income – 30 percent tax, unless net election available.

2)  Branch profits tax is ETBUS.

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Problem 1, Continued

3)  Listed securities investments – interest and dividends, subject to 30 percent withholding.

4)  Sale of real estate – FIRPTA

5)  Sale of securities – no tax, unless connected with real estate trade of business.

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Problem 1, Continued

6)  Dividends from Panco producing U.S. taxable income, unless branch profits tax.

7)  Use debt leveraging?? But Section 163(j) may be applicable.

8)  Cayco –

Where rendering services?

Not subject to FIRPTA.

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Problem 2 p. 297

How much investment? Profit projections? Cash flow expectations? How deal with U.S. profits? Income tax status of the individual? Anticipated structure and management?

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Problem 3 p. 297

Nontax considerations, e.g., limitation of liability. What alternative structures for tax planning? Debt financing? Resident alien status of individual? Branch profits tax & FIRPTA applicable?

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Summary p. 298

Investment environment in U.S. – Are tax burdens on foreign investment more favorable than for domestic based investment? Cf., force of attraction rule vs. P.E. test (with only P.E. income being taxed). Consider focus of U.S. income tax treaties.

Documents

Presentation: International Income Taxation Chapter 4 ... Chihuahua Gas p. 234 881(a) as Basis for Decision Rent not paid by a Mexican corporation (HIDRO) ETBUS to related Mexican