Presentation:
International Income Taxation
Chapter 4: FOREIGN PERSON’S NONBUSINESS US SOURCE INCOME
Professors Wells
February 10, 2016
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).
Passive Investor: Withholding
Chapter 4
“Fixed
Determinable
Annual
Periodical”
But, FDAP can be “effectively
connected” with a U.S. trade or
US ToB/ECI
US P.E./Bus. Profits
business and then be taxed on a net
income basis. §864(c)(2).
Active: “Net Basis Tax”
M
(Foreign Corp)
(with Branch Profits Tax)
Chapter 3
Possible modification of the
applicable (gross withholding) tax
rates by (1) a Code section or (2) a
bilateral U.S. income tax treaty.
2
Why impose tax on a gross basis?
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).
P. 229
Passive Investor:
Withholding
“Fixed
Determinable
Annual
Periodical”
30% or
ate
Treaty R
M
(Foreign Corp)
Is 30% the appropriate tax rate? Cf.,
corporate tax rate of 35%.
3
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.
Passive Investor:
Withholding
“Fixed
Determinable
Annual
Periodical”
30% or
ate
Treaty R
M
(Foreign Corp)
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.
4
Wodehouse Case
Disposition
One Payment Disposition
sLump
received
for an
sum amount
was received for an
book right in the United States.
n exclusive
the United
Sale of the property interest
in a copyright.
Held: one lump sum amount
terest
(not contingent) represented
the acceleration of all the
royalties and, therefore,
FDAP.
mount (not
not need multiple
dDo
the
payments to have “annual or
royalties
and,
periodic” payments.
p. 231
FDAP Income Additional Examples
p. 232
Rev. Rul. 73-522 Illustration
1)  Rental income gross-up
for expenses or real estate
taxes paid by tenant –
County Property
Rev. Rul. 73-522
Assessor
2)  Annuity payments from a
Lessor
US-Owned
Rent
U.S. insurer. Rev. Rul.
(Foreign Corp)
Parent
2004-75. Treated as
having a U.S. source even
Extra Rent
though sold by a foreign
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.
6
Chihuahua Gas
§881(a) as Basis for Decision
p. 234
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.
US Tractor
Fleed
Chihuahua Gas
Corporation
Rent
Free
US
Office
Hidro
Corporation
Must an actual payment be made to
trigger (1) §881(a) & (2) withholding at
source?
7
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)
8
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.
9
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?
10
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: -0Royalties: -0- (cross-licensing – next slide)
Pensions, annuities and alimony payments: -0Annuity defined – see Abeid case, p. 243
11
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.
12
“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?
13
Aiken Industries Conduit Arrangement
ECL
Transaction Steps:
2
1)
2)
MPI borrows from ECL.
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
1
CCN
Aiken
Industries
4
MPI
Industrias
3
Valid business purpose?
14
Rev. Rul. 84-152 (now obsolete)
Swiss parent with U.S. operating
sub and Netherlands Antilles
financing sub (brother-sister
subsidiaries).
1
P
Switzerland
S
Antilles
2
R
United States
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?
15
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?
16
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
17
Limitations on “Treaty Shopping” – Treaty & Code
p.255
Ingersoll-Rand v. Commissioner, T.C. Dkt. No. 025769-13
I-R Company Ltd.
(Bermuda)
3
3
Global Hldg.
(Bermuda)
Loan
1
Loan
I-R (Barbados) Hldgs
(Barbados)
IRCO Note
$3.6 billion / 11%)
2
IRCO Note
Interest
3
Lux Note
Ontario 3
(Hungary)
3
I-R (Luxembourg) S.a.r.l.
(Luxembourg)
3
est
Inter rate wht)
(5% treaty rate wht)
I-R Company
(Delaware)
2
2
eaty
r
t
0%
(
December 29, 2015: Court order issued that IRS and Ingersoll-Rand agreed to an $86
million withholding tax assessment
18
Hybrid Entities Cross Border Arbitrage
Pre-§894(c) Idea for Homeless Income
p. 257
NA General Partnership, et al. v. Commissioner, TC Memo 2012-172
(Scottish Power)*
ReverseHybridEn:ty
Parent
(U.K.)
U.S. Tax
Consolidation
Subsidiary/Partnership
United States
$932million
(CashDividend)
Target
United States
* Note: Tax years predated Section 894(c) proposed regulations targeting this structure
19
Hybrid Entities Cross Border Arbitrage
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.
Question: does the US-Netherlands,
US-Switzerland or no treaty apply?
P
Switzerland
1
S
Netherlands
R
United States
2
R
United States
§894(c) limits treaty benefits and denies
3
deductibility in the NA General Partnership fact Interest
pattern (i.e., deductible interest in that fact
patterns becomes dividend [to extent of amount of
Dividend
dividend to reverse hybrid] for all tax purposes).
Hybrid
P
Switzerland
S
Netherlands
Reverse
Hybrid
P
Switzerland
S
United States
Dividend
Foreign (forward) hybrid entity:
p. 257
R
United States
20
Treaty Shopping
Problem 1
p. 259
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).
Olson
Johnson
ILL
(Sweden)
AmFish
(US Corporation)
21
Problem 2: Substantial Presence Test?
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.
p. 260
Olson
Johnson
ILL
(Sweden)
AmFish
(US Corporation)
22
Problem 3
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.
p. 260
Superrich Corp
(Brazil)
ILL
(Sweden)
AmFish
(US Corporation)
Or, an active trade or
business in Sweden – Article
22(3).
23
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?
Public
(Swedish Exchange)
ILL
(Sweden)
AmFish
(US Corporation)
24
Problem 5
ILL Shares Traded & Sold
Shares listed and 75 percent of
shares sold mostly to nontreaty 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.
p.260
Public
(Swedish Exchange)
ILL
(Sweden)
AmFish
(US Corporation)
Therefore, must Art. 22(2)(e)
test be satisfied? Percent
owned by Swedish?
25
Problem 6
Shares Are Sold Directly to 3rd Country
p.260
75 percent of the ILL shares are sold directly
to non-treaty country residents and not
publicly listed.
Brazilian S/H
Article 22 will deny treaty benefits to ILL.
Why deny the tax treaty benefit when the
shares are not publicly traded?
Johnson
75%
25%
ILL
(Sweden)
AmFish
(US Corporation)
26
Problem 7
The “Base Erosion” Test
p. 260
Loan from bank in Norway to Partsub
in Sweden and then loan to parent in
U.S.
Loan
Norwegian
Bank
Loan
Interest
Partsub being used as a financing
subsidiary, although already an
operational(?) sub.
AmCorp
(US Corporation)
PartSup
(Sweden)
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.
27
Problem 8
Base Erosion Test
p. 260
Loan from bank in Norway to sub in
Sweden to parent in U.S.
Amcar (Parent corp.) guarantees the
loan to Partsub.
Loan
Norwegian
Bank
Loan
Interest
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).
AmCorp
(US Corporation)
PartSup
(Sweden)
28
Problem 9
Base Erosion Test
p. 260
Loan from (1) bank in Norway to sub
in Sweden (2) to parent in U.S.
AmCorp
(US Corporation)
Anti-conduit rules would almost
certainly apply. Reg. §1.881-3(a)(4)
factors appear to be present.
Loan
Norwegian
Bank
Loan
Interest
Partsub organized shortly before the
loan agreements were concluded.
PartSup
(Sweden)
Objective of the intermediary is to
reduce U.S. income tax.
29
Capital Gains
Source to the Residence
p. 260
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?
30
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).
31
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.
32
Cascading Royalties
Foreign Withholding Agent
p. 263
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.
Royalty
A
Non-Treaty
License
US IP
Royalty
X
Netherlands
Sub- License
US IP
Y
United States
33
SDI Netherlands
Withholding Agent Issue
p. 265
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.
Royalty
SDI
Bermuda
License
Global IP
Royalty
SDI
Netherlands
Sub- License
US IP
SDI
United States
34
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?
35
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).
36
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.
37
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.
38
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?
39
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).
40
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”?
Foreign
Shareholder
Buyer
US RP
Holding Company
US RP
Holding Company
41
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).
42
Code §1445
FIRPTA
Withholding at Source
Transferee must withhold 10
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).
p.284
Foreign
Shareholder
Buyer
US RP
Holding Company
US RP
Holding Company
Cf., possible information reporting.
43
Code §1445 Exceptions to FIRPTA
Withholding at Source
p.285
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%).
44
Code §1445 & Entity Distributions
p. 286
Foreign corporate distributions –
withhold 35% of the gain amount.
Tax applies to the corporation which
knows its tax basis for distributed
asset. §1445(e)(2).
U.S. corp.? 10% on liquidation
distributions.
Foreign
Shareholder
Stock
Partnership & trust distributions –
Cash
US RP
Holding Company
Withhold 35% of the gain realized
to extent allocable to a foreign
partner/foreign trust beneficiary.
§1445(e)(1).
45
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.).
46
Financing the US Enterprise
Foreign party capitalizes the U.S.
subsidiary with both (1) debt and (2)
equity.
p. 287
Base Erosion: Interest Stripping
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).
Foreign
Parent
Interest
vs.
Dividends
US
Subsidiary
What is “debt” as contrasted with
“equity”?
See Code §385.
47
Is Excessive Interest Deductible?
“Earnings-stripping” – re (tax
exempt) interest paid to related
party - §163(j).
p. 288
Base Erosion Defense: §163(j) Earnings Stripping Rules
The deduction for “disqualified
interest” is postponed.
Interest Income is LowTaxed in foreign Country
Foreign
Parent
What is “excess interest
expense”?
Debt to equity ratio must exceed
1.5 to 1.
US
Subsidiary
Interest Deduction
Reduces US Tax
Base
Applicable when a U.S. income
tax treaty provides a tax rate
reduction on interest, i.e.,
proportionate reduction.
48
Earnings Stripping Via Interest Deductions?
High Profile Re-Leveraging Transactions
Foreign Owned MNE Structure
GlaxoSmithKline
GSK Investment
(Switzerland)
$13.5 Billion Intercompany Debt
Tax Deficient of $864 million (2001-2003)
Additional Exposure of $1.06 billion (2004-2008)
GSK Americas
(US)
IRS Conceded Case Before Trial
p. 288
Inverted MNE Structure
Tyco
Tyco Int’l
(Switzerland)
Interest: $2.8 billion (tax of $883 million)
(add’l $6.6 billion of interest in later years)
Tyco Electronics Corp
(US)
Outcome: Tyco settled for
~$220 million with
another $250 million
in later years.
49
Treatment of Guaranteed Debt?
This debt includes unrelated
party loan interest where a
related foreign person
guarantees the debt.
p. 289
Base Erosion Defense: §163(j) Earnings Stripping Rules
Foreign
Parent
Guaranteed debt also includes
debt where, e.g., the parent
corporation provides a “comfort
Last Bank
letter”.
Standing
Guarantee
Interest
US
Subsidiary
Not relevant when the subsidiary
is the guarantor. Why?
Note: Jobs Act Study (2004) re
Code §163(j).
50
Problem 1
Securities Income & Trading
p. 292
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).
51
Problem 2
Excess Capital Loss
p. 292
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.
52
Problem 3
Discretionary Authority
p. 292
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.
53
Problem 4
§864(b)(2)(B) Safe Harbor
p. 292
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.
54
Problem 5
Cf., Balanovski Scenario
p. 292
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.
Bolanovski
Horenstein
CADIC
(Argentina)
Customers pay transit insurance.
Not a USTB or P.E.? If so, what
income source (U.S. for foreign)?
55
Problem 6
Related U.S. & Foreign Parties
p. 293
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.
And, no imputed U.S. status
because the transaction is between
related companies.
Colonial
(US Corporation)
Sale
Empire
(German)
Sale
Foreign corp. receives foreign
source income from the sale of
inventory. U.S. tax? No.
Holdco
(Swiss)
European
Customers
56
Problem 7
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.
p. 293
Holdco
(Swiss)
Colonial
(US Corporation)
Commission
Empire
(German)
European
Customers
57
Problem 8
Royalties or Compensation?
p. 293
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.
58
Problem 9
Community Income
p. 293
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?)
59
Problem 10
Outbound Alimony & Interest
p. 293
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?).
60
Problem 11
Partnership Services §1446
p. 294
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?
61
Problem 12
U.S. Land Ownership USTB?
p. 294
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).
62
Problem 13
Sale of U.S. Land & FIRPTA
p. 294
NRA sale of U.S. land (i.e., real property).
U.S. income tax treatment of the profit?
Purchase Pr
ice Les
Leonardo 10% Withholdin s
g
&
US Buyer
Verdi
Yes, §897 imposes tax – FIRPTA rules.
§1445 imposes a withholding obligation at
source on the payor.
US Real Estate
U.S. Model Income Tax Treaty, Article
13(1), confirms that U.S. jurisdiction exists
to tax these real property gains.
63
Problem 14
USRPHCo Status? 50%+ Test
NRA invested in wholly owned U.S.
corporation:
p. 294
Romano
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.
Knickerbocker
(US Corporation)
Stock
Issue: Did USRPI > 50%
of value in last 5 years?
64
Problem 15
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.
p. 295
Romano
Knickerbocker
(Cayman Corp.)
Stock
Issue: Did USRPI > 50%
of value in last 5 years?
65
Problem 16
Indirect U.S. Ownership
p. 295
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
Public
sale
Blue Water
(US Corporation)
Paradise
(Bahamas Corp.)
Caribbean Hotels
Florida Hotels
Issue: Look-through Paradise and
Determine relative value of real property.
66
Problem 17
Disqualified Interest & §163(j)
p. 295
Interest stripping issue: Interest of $280,000 is disqualified interest
under Code §163(j)(3)(a) – (1) interest is paid to a related party and
(2) no tax applies to interest under the treaty. Debt equity ratio of
2.8:1 exceeds the 1.5:1 limitation.
Excess interest ($30,000) results from $280,000 interest expense over
50% ($250,000) of adjusted taxable income. ($500,000, resulting
from gross income: $200,000; depreciation: $20,000; and interest
expense: $280,000). §163(j)(1)(A).
67
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.
68
Problem 1
Tax Planning
p. 296
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.
69
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.
70
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.
71
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?
72
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?
73
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.
74