Tag Archives: branch profits tax

U.S. International Tax Planning for the Canadian and U.K. Investor in U.S. Real Estate

The goal of the U.S. International Tax Planning for the Canadian and U.K. Investor is to a double tax issue.  On one side, there is income tax.  On the other hand, there is inheritance tax (for the U.K. citizen), estate tax in the U.S. (which will be repealed but only for a few years) and the Canadian deemed sale at death tax.

We all want the American 20% long-term capital gain tax rate.  However, this means the foreign investor can’t own the U.S. real estate in a corporation.    Both a domestic corporation and a foreign corporation incur two U.S. income taxes.    For the domestic corporation, the second tax is called “the accumulated earnings and profits tax”.

For the foreign corporation, the tax is called the “branch profits tax”.   Foreign shareholders of a corporation owning U.S.  real estate are subject to the U.S. estate tax (but not the gift tax).

U.S. International Tax Planning for the Canadian and U.K. Investor uses a Nevada Trust

Wealthy Americans have the same tax problem.  They solve the problem by using a special type of a trust.  Here is a short video on reducing U.S. taxes with the use of a trust.   If you want to learn more about a Nevada Self-directed trust for your tax planning, then contact me, Brian Dooley, CPA,MBT  at [email protected]

A Nevada is one of the few states that have a special trust law. It is called a “self-directed” trust. As the name implies, you can direct the trustee.   The IRS has issued favorable rulings on this type of trust. 

Basics of International Taxation for the Foreign Corporation

The basics of international taxation for the foreign corporation doing business in the United States is divided into two components.   The one that all of you know is the  income tax.  This tax applies when the foreign corporation has an office or a facility such as a warehouse.

The next component is the branch profits tax. This law looks at the change in the net worth of the foreign corporation each year.

This tax applies to the withdrawal of assets from the foriegn corporation.   The tax can also apply when the foreign corporation keeps assets that it no longer needs in order to avoid the branch profits tax.

Basics of International Taxation for the Foreign Corporation doing Business in the U.S.

When a taxpayer tries to avoid this tax,  the law become complex.  Avoiding this tax makes sense in those cases where the law wants to tax foreign profits.  In many cases, the way you design your business decides the taxation.

In most cases, the tax law makes sense.  For example, a United Kingdom corporation opens an office in California.  The office includes a warehouse for its inventory.  The inventory is imported from the U.K. office.

The California office sales throughout the United States.   All of the income is taxable by the U.S. and California.

The U.K. office charges a “stewardship fee” for the worldwide marketing, the accounting and the time of its UK directors in managing the California office.  As long as the fee is not inflated, the stewardship fee is tax deductible.

When sales are made outside of the U.S., the tax law looks at where title passed on the sale, whether the California office or the U.K. office negotiated the sale and approved the sale.  This last factor may depend on the business’s website “terms and condition” page.  You want his page to reviewed by your international tax accountant and attorney.

Basics of International Taxation for Branch Profits Tax

This tax has two components.  As stated above, the withdraw of networth from the California office will cause this tax apply.  Since a U.K. corporation is involved, the tax rate is 15% and not 30%,   The key to manage this tax, is good and update to date accounting.  Your accounting needs to be a  double entry general ledger.   This method has been used for 500 years.

The other part of the branch profits tax is the “excess interest”.  This law is a complex equation that looks at worldwide borrowing and worldwide interest expense.   The law has an amount that the law considers excess.

Once again, managing this tax requires timely accounting and accurate accounting. Here is an blog post on avoiding the branch profits tax.

If you want to learn more about the foreign corporation’s tax return (Form 1120F), please click on this link.b

If you need help with your Form 1120F, contact me, Brian Dooley, CPA, MBT, at [email protected]

Branch Profits Tax The Foreign Corporation Double Taxation

The branch profits tax  is a complex tax law.  It is composed of two very complex math equations.  Here is a summary.  

This is one of the trickier American tax laws.  It applies when foreign corporation has a business in the U.S.  This includes a business owned by a partnership or a limited liability company (LLC). 

When money or other assets are removed from the business, the tax applies.  “Removed” means that the money or asset is distributed to the shareholder or is transferred out of the U.S. business. 

The branch profits is similar to an old  tax law that applies to domestic corporations that have accumulated earnings.  Under this tax law (Section 531), a domestic corporation is  subject to dividend tax if it accumulated assets more than its working capital needs.  This same rule applies to the branch profits tax.   

Imagine that during a tax audit, the IRS decides that you had more working capital than the IRS believed is necessary (with the advantage of hindsight). The corporation owes tax of 30 percent of the asset value, penalties, and interest.

For example, a BVI company opens an office in Texas to expand into the U.S. market. The BVI company net income,  after U.S. income taxes, is $1,500,000.  $500,000 is transferred to the Company’s  U.K. office in London.   

The removal of $500,000 of net equity is taxed at 30%.  The tax is $150,000.  

If the company has been a United KIngdom company instead of a BVI company, the tax rate would be be 30%.  The tax rate would be the lower tax rate found in the U.S-U.K. Income Tax Treaty.

I have a technical summary of branch profits tax at this hyperlink

This link has ideas on winning a branch profits tax audit.

Branch Profits Tax Causes a Double Taxation of U.S. Business Income (Including Real Estate).

 A fatal approach of the foreign business operating in the United States is the use of a foreign corporation to own the American business. The branch profit tax law classifies the American operation as a branch office of the foreign corporation.

This branch office classification occurs regardless of the existence of a foreign headquarters or home office. The branch office is an income tax concept found in Section 884.

Many times, the foreign corporation will form a domestic limited liability company (LLC), which is just as fatal. A single member LLC (SMLLC) does not exist as a separate entity for income taxes. The result is that the foreign corporation is seen as if it directly opened a branch office.

Often a foreign corporation will own a portion or all of a domestic limited liability company (LLC). This structure has the same flaw unless the LLC elects to be taxed as a corporation. Without the election, the LLC is a partnership. The foreign corporation has a branch in the U.S. as to its portion of the LLC.

The branch profits tax is in Section 884; It consists of three main parts:
1. Tax on the removal of earning from the U.S. business or the keeping of assets to avoid the tax,
2. Branch-level interest tax on and
3. An anti-treaty shopping rule.

(1) The branch profits tax – Regulation 1.884-1 has the rules for computing the tax.

The branch profits tax is 30 percent tax on the after-tax earnings of a foreign corporation’s U.S. trade or business that are not reinvested in a U.S. trade or business by the end of the taxable year.

The amount subject to the branch profits tax is the “equivalent dividend amount” which is defined as the reduction in the net worth of the U.S. business.

 One may feel that by merely keeping all of the net profits in the U.S. branch that you can avoid the tax.  However, that is not the case.  You must prove the business reasons for not distributing the money to the home office or the shareholder.  

 The IRS has years of experience in a similar law with corporations taxed under subchapter C.[1]   Like the branch profits tax; this law taxes a domestic corporation a second time if it retains money not needed for its business.   The accumulation of profits beyond the reasonable needs of the corporation is taxed as dividend.

Section 1.884-2T contains special rules regarding the termination or incorporation of a U.S. trade or business, or the liquidation or reorganization of a foreign corporation or its domestic subsidiary. In these cases, the tax does not apply.

 (2) The branch-level interest tax. This is a complex math equation.  The basics are below.

 Section 1.884-4 provides rules for computing the branch-level interest tax. In general, interest paid by a U.S. trade or business of a foreign corporation (“branch interest,” as defined in Section 1.884-4(b)) is treated as if it was paid by a domestic corporation and may be subject to tax under Section 871(a) or 881, and to withholding under Section 1441 or 1442.

Also, when the interest allocated to the U.S. business income exceeds branch interest, the excess is treated as interest paid to the foreign corporation by a wholly owned domestic corporation and is subject to tax under Section 881(a).  The tax rate for section 881(a) is thirty percent.

Footnote

[1] Section 531 a tax on accumulated earnings and profits.

International Tax Strategy for the United Kingdom, Deutschland, and Français Business owning a U.S. Subsidiary Corporation

What is the best international tax strategy for the United Kingdom, Deutschland, and Français Business owning a U.S. subsidiary corporation?

The answer is long and complicated.  So, please get a cup of tea or coffee and spend a few minutes.    One choice is for the U.K., German or French company to merely open a branch in the U.S. and not form a U.S. corporation.

Legally; this is easy.  The company will register with the state(s) where it is doing business.  If it has employees, it will register with both the IRS and the states.   

The other choice is for the U.K., German or French company to create a subsidiary corporation in the state that will be their U.S. headquarters.  If it has employees, it will register with both the IRS and the state.

The U.S. corporation pays income tax on its worldwide income. The maximum U.S. corporate tax rate is 35% (as of October 2017).  This rate may drop to 20% starting in 2018.

Most states also have an income tax.   So far, it is simple. However, with more than 1,000,000 pages of tax law, it quickly becomes complex.

We start with capitalizing the corporation.   American tax law is anti-debt and especially shareholder debt.  

For example, Keith’s U.K. company starts a California corporation. The U.K. company invests $1,000 in the common stock and loans a $100,000 to the corporation.  The loan is evidenced by a written promissory note and has a reasonable interest rate. The promissory note was approved by the directors of both companies.

The California corporation had a successful first year and paid back the $100,000.  The U.K. company has $100,000 of U.S. taxable income. Yes, the repayment is taxable. 

Why is the loan repayment taxable?   The California corporation was “thinly capitalized”.  For the U.S. standpoint, a loan is treated as preferred stock when the loan exceeds 33% of the capital (including retained earnings).  This tax law is called debt versus equityThis link has more information. 

And there is more bad news for international debts.  If tax treaty exempts the interest income from U.S. tax, a U.S. corporation cannot deduct only a portion of the interest expense.  This law is complicated, and I have an explanation on this page. 

The goal of this law is to prevent the foreign person from removing money from a U.S. corporation free of U.S. income tax.   Luckily, the tax treaties with the U.K., France, and Germany require a U.S. tax and thus interest paid to a residence in this country is not affected by this law.

Avoiding Double Taxation with an International Tax Strategy for the United Kingdom, Deutschland, and Français Business owning a U.S. Subsidiary Corporation or a Branch.

The U.S. tax law wants double taxation on all corporate profits. For the foreign corporation with a branch, this tax is called the “branch profits tax” 

The tax law expects the corporate profits to be paid the shareholder as a dividend.  The U.S. tax rate on a dividend paid to a foreign person is the lower of 30% or the rate found in the tax treaty.  

The rate is between 5% to 15% for in the U.K., France and German tax treaty (please see more on this link).  The tax is withheld by the paying domestic subsidiary. 

For example, the  California corporation had a successful first year.  The business made $250,000.  The U.S. tax is $80,000, and the California tax is $22,000.   

The U.K. company pays out the remaining profit of $148,000 to the UK parent company.   U.S. tax law classifies this as a dividend.  Assuming that the ownership of the U.K. company qualifies for the U.K.-U.S. Tax Treaty for the direct dividend rate, the U.S. tax is $7,400. 

The California corporation withholds the $7,400 and  pays $7,400 directly to the IRS.  The U.K. parent company receives $140,600 ($148,000 minu $$7,400).   By the way, many types of payments of U.S. source income to a foreign person require the tax to be withheld and paid directly to the IRS.  Here is a link with more on this topic. 

How about foriegn  management fees, consulting fees, and other stewardship fees? 

Unlike other nations, you can go to prison for paying these fees unless you can prove that the foreign person did work and the payment is reasonable (read more on this link).

The U.S. courts will want to see your time journal (showing what you did, the day you did the work and the time you spent), proof that the hourly rate is valid and the business reason as to why the foreign person did the work and not someone in the United States.

How about international licensing the technology or a trade name or a trademark?

Much like the payment of fees above, you need to have proof as to the value to the U.S. corporation.   When the amount of the licensing payment is inflated, not only is the deduction disallowed, the event may be considered a crime.

You must be able to prove that the  price paid for  goods, services and licensing is the price that an unrelated person would pay.   

International Tax Strategy for the United Kingdom, Deutschland, and Français Business with a  Cost Sharing Agreements to Shift Profits

Cost sharing is a sophisticated international tax strategy. The courts continue to uphold international tax planning using cost sharing agreements.  You can learn more on this topic on this link.

What if the U.S. corporation does not pay a dividend?

A second corporate tax applies when a corporation does not have a business reason for not paying a dividend to a shareholder.   In the example above, if the profits are needed to expand the business, for a cash reserve for unforeseen events, then the second tax will not apply.

Assuming that the U.K. company ownership qualifies under the tax treaty of the five percent rate on dividends, then the second tax is five percent.

Does the U.S. subsidiary corporation causes the U.K. company to pay U.S. income taxes?

It might!   Here is what has happened, on  this link.  

Finally, there is the U.S. estate taxes for the non-resident alien.

 Assuming that Keith is the sole shareholder of the U.K. company, the value of the California corporation could be subject to U.S. estate taxes upon his death.  Here is more on this topic. 

If you would like to discuss your plans of opening an office in the  United States, then please email me at [email protected]

 

Form 1120-F U.S. Income Tax Return of a Foreign Corporation

Table of Contents for Form 1120-F U.S. Income Tax Return of a Foreign Corporation Tax Planning

1. This blog tells you how to protect yourself from the U.S. courts and the IRS.
2. his blog is primarily about U.S.  international income taxation and the branch profits tax.
3. Two important international tax laws to watch.
4. Tax Planning for your Balance Sheet and the Branch Profits Tax.
5. Liability Of Corporate Agent in the USA.

6. You Must Timely File  Form 1120F to Claim Deductions or Credits.
7, Protective Filing of Form 1120F:  Smart International Tax Accounting.
8. What if only part of your U.S. income is U.S. business income?

This just might be the most important blog on international tax that you will ever read. Here is the problem for U.K., EU, Australian, New Zealand, and Canadian corporations with U.S. income.

The internet is full of stories of how the tax treaty permanent establishment article prevents the USA from taxing you.  What the stories don’t tell is that the U.S. Tax Court does not care about your tax treaty.

The U.S. Tax Court is part of the Government.  The Government wants your money.  It is that simple.  Okay, it’s not fair.  But they really  do not care.  This link discusses a few of these anti-tax treaty court cases.

This blog tells you how to protect yourself from the U.S. courts and the IRS.

Form 1120-F U.S. Income Tax Return of a Foreign Corporation covers three different taxes. 

Foreign corporations have income from U.S. sources are always required to file U.S. tax returns.
Three different taxes are on the form as follows:

  1. Foreign corporations must pay a 30 percent tax on income from U.S. sources not connected with a U.S. trade or business.
  2. Foreign corporations engaged in trade or business within the United States is subject to income tax, alternative minimum tax, and other taxes applicable to corporations on their taxable income.
  3. Foreign corps engaged in business within the U.S. must pay the branch profits tax.

This blog is primarily about U.S.  international income taxation and the branch profits tax.

A foreign corporation with a business in the United States at any time during the tax year or that has income from United States sources must file a return on Form 1120-F.  A foreign corporation with U.S. business income must file (I will explain why later in this blog) even though:

(1) It has no business income (that is income effectively connected with the conduct of a trade or business) in the United States,

(2) It has no income from U.S. sources  or

(3) Its revenues are exempt from income tax under a tax convention or any provision of the tax law.

Two important international tax laws to watch.

  1. If the foreign corporation has no gross income for the year, it is not required to complete the return. However, it must file a Form 1120F and attach a statement (I will explain why later in this blog) to the return indicating the nature of any tax treaty exclusions claimed and the amount of such exclusions to the extent these amounts are readily determinable.[1]  For example, if you believe that you have avoided having a permanent establishment, you need to explain why.  Here is more on court cases on permanent establishment).
  1. To claim tax deductions and credits,  the corporation must file an accurate tax return on time. If the return is not timely file, all of the expenses and costs of goods sold can never be deducted.  If the U.S. income of a foreign corporation includes income that is subject to a lower rate of tax under a treaty, it must attach a statement to its return explaining this and showing:

(a) The income and amounts of tax withheld,

(b) The names and post office addresses of withholding agents, and

(3) any other information required by the return form or its instructions.[2]

Tax Planning for your Balance Sheet and the Branch Profits Tax.

The foreign corporation may elect to limit the balance sheets and reconciliation of income to the U.S. business use assets, liability and equity and its other income from U.S. sources.[3]   The branch profits tax traces the U.S. business equity and debts.  Thus, the balance sheet is the IRS’s primary audit tool.   Reporting your worldwide assets is providing the IRS information that has little or no value.

TAX TIP: A foreign corporation that is not engaged in a trade or business in the United States it is not required to file a return when the U.S. withholding of tax at the source of its payments covers the taxes owed.   A matter of fact, the goal of U.S. withholding tax is eliminated U.S. tax compliance for the foreign person.

Liability Of Corporate Agent in the USA

A representative or agent of a foreign corporation must file a return for and pay the tax on the income coming within his control as representative.   The agent can include a related corporation or an individual.

You Must Timely File  Form 1120F to Claim Deductions or Credits

I can not say this too often. A foreign corporation must its return on time to take deductions and credits against its U.S. business income.[4]

However, the following deductions and credits are allowed even if such a return is not filed:

(1) the charitable deduction;

(2) the foreign tax credit passed through from mutual funds;

(3) the fuels tax credit; and

(4) The credit for income tax withheld.[5]  

Timely filed means the Form 1120-F is filed no later than 18 months after the due date of the current year’s return.  

But it is more complicated, and you must read this:  I know this next section is tricky.  So, please be patient.  However, if you need help, then contact me, Brian Dooley, CPA, MBT  at [email protected] 

When the return for  the prior year was not filed, the return for the current year must have been filed no later than the earlier:

  1. of the date which is 18 months after the deadline for filing the current year’s return, or
  2. the date, the IRS mails a letter to the foreign corporation advising it that the current year return has not been filed and no deductions may be claimed it.[6]

The IRS may waive these deadlines when the foreign corporation proves that:

  1. It acted “reasonably and in good faith”  in failing to file a U.S. income tax return (including a protective return), and
  2. cooperates in determining its income tax liability for the year for that the return was not filed.[7]  

 Protective Filing of Form 1120F:  Smart International Tax Accounting 

This is the smartest thing you can do as a foreign corporation.   The chances of an audit are low and the tax protection is high.  I have the rules below. 

A foreign corporation with limited activities in the United States that it believes does  not give rise to U.S. gross business income should file a protective return.  

A timely filed protective return preserves the right to receive the tax savings  of the deductions and credits if it is later determined that the foreign corporation did have a U.S. business.  

Here is the very good news:  On that timely filed protective return, the foreign corporation is not required to report any gross income taxable income and thus pays no net income tax or branch profits tax.  

However, do not forget to attached a statement indicating that the return is being filed as a protective return and to check the box on the Form 1120F.  Also, you must include your tax treaty disclosure IRS form. Be sure to attach the IRS tax treaty disclosure Form 8823, on this link.  

What if only part of your U.S. income is U.S. business income? 

If the foreign corporation determines that part of the activities is U.S. business gross income that U.S. business income and part are not, then the foreign corporation must timely file a return reporting the U.S. business gross income and deducting the related costs and expenses.  

Important: Also, the foreign corporation must attach a statement that the return is a protective return about the other activities.   The protective election ensures that it can deduct the related expenses if the IRS should disagree.  

The same procedure is available if the foreign corporation when if they initially believe that it has no U.S. tax liability due to a tax treaty.[8]  Be sure to attach the IRS tax treaty disclosure Form 8823, on this link

As discussed above, many foreign corporations believe that their home country tax treaty “permanent establishment” provisions protect them since they do not have an office in the U.S.  However, the U.S. courts treat almost any office (even an office owned by an agent or a related person) as a permanent establishment.  

Lastly, U.S. Department of the Treasury will guide you and provide you with a tax guarantee.  This is known as a private letter ruling.  Here is more information.

FOOTNOTES

  1. Section 1.6012-2(g)(1)(i).

If the foreign corporation with a place of business in the United States, the return must be filed by the 15th day of the third month after the end of the tax year.

[2] Reg. Section 1.6012-2(g)(1)(ii).

[3] Reg. Section 1.6012-2(g)(1)(iii).

[4] Code Section 882(c)(2).

[5] Reg. Section 1.882-4(a).

[6] Reg. Section 1.882-4(a)(2).

[7] Reg. Section 1.882- 4(a)(3).

[8] . Reg. Section 1.882-4(a)(3)(iv).