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Court Explains Offshore Company International Tax Plan

tax planning, saving taxes, how to save taxes, tax court

Tax Court explains great tax planning in this case.

This blog is about “Offshore Company International Tax Plan” approved by the the U.S. Tax Court.   The court’s  blueprint on offshore tax planning with a tax haven corporation will cut your tax burden in half.  

 In this Tax Court case, a private annuity was used to fund the foreign corporation.   The   corporation invested in publically traded stocks. 

A private annuity with a foreign corporation is a popular tax plan for the very rich.

What I like about the case, is that the IRS is the victor.  This means the IRS is not likely to disagree with its court victory

Offshore Company International Tax Plan with a Private Annuity

It works like this.  I form a BVI company with $10,000 as capital.    Then I fund my BVI corporation with an additional $90,000.  However, this time my corporation signs an agreement promising me an annual payment of $8,000 a year for the rest of my life or until I dissolve my corporation.    This arrangement is called a “private annuity.”

My BVI company earns $8,000 a year on its $100,000 (the $10,000 for the capital and the $90,000 for the private annuity).  It also deducts the $8,000 it pays me on the annuity,  leaving the corporation with no taxable income.   However, the annuity income tax rules, section 72, allocates $4,000 a year to my cost.  Of the $8,000 I received on the annuity, only $4,000 is taxable ($8,000 minus my allocated cost of $4,000).

I cast my tax planning is stone by filing IRS Form 5471.  Of course, I reference the IRS Tax Court case victory on the Form 5471. It is in this form that I report the activity of my offshore tax haven corporation.  As you may know, Congress enacted new laws to improve offshore corporations.  Here is a link with the basic.

Listen to our internet radio show, Tax Talk,  below (the show is about 15 minutes) to learn how to save taxes on your investment income with your controlled foreign corporation funded by your private annuity.  The term “private annuity”  means that no insurance company is involved.  Only you and your corporation are involved.  

Too busy to listen now? Ok.. then download the episode from our free Itunes page on this link.


Seemingly innocent but deadly to the IRS, private annuities have saved taxes since the beginning of the 1900’s.   But, now they are better.  The U.S. Tax Court agreed that private annuities paid by a tax haven corporation avoid all of nasty the anti-tax haven laws.

It gets better.  The IRS private  annuity interest rates are at an all-time low (about two percent).  This allows for income shifting to your offshore company.

Something as simple as your controlled foreign corporation funded with your money provides tax savings and asset protection beyond your wildest dreams (tax dreams that is).

The trick?   The trick, as you will learn on our internet radio show, Tax Talk (below), is the IRS’s information return, regulations and a recent Tax Court victory in  Dante and Sandi Perano, Petitioners vs. Commissioner of Internal Revenue.

Need Help with your Offshore Company International Tax Plan

If you need advice for your office company international tax plan, then contact me, Brian Dooley, CPA, MBT, at [email protected]

Easy Tax Planning for Tax Free Foreign Income for the Non-resident and Foreign Corporation

Tax planning for foreign corporations and non-resident aliens starts with looking at the income. A foreign person does not pay U.S. income tax on many types of U.S. income.  Unlike the UK and Europe, the U.S. can be the company’s headquarters and not pay tax U.S. taxes on the foreign income.

Avoiding the value added tax increases the business working capital by 25%.  While the VAT is often as low as 17%, the UK or EU business pays the VAT with after income tax profits.   This causes the VAT to be a 25% drag on working capital.

The U.S. is the only industrialized country that does not charge this anti-business tax. The tax planning rules for determining tax-free foreign source income are summarized in the guide below in blue print to be used  for tax planning for foreign corporations and non-resident aliens

Summary of Source Rules for Income of Nonresident Aliens

Item of IncomeFactor Determining Source

Salaries, wages, other compensation

Where services performed

Business income:
Personal services
Where services performed
Business income:
Sale of inventory -purchased
Where sold- where the customer takes possession of the property.  A foreign business can warehouse and store their inventory in the U.S. This is a popular way to avoid the VAT.

Business income:
Sale of inventory -produced

Where produced (Allocation may be necessary)

Interest

Residence of payer- except for bank deposit interest is tax free to the foreign person

Dividends

Foreign source when paid by a  foreign corporation
U.S. source from a domestic corporation

Rents

Location of property

Royalties:
Natural resources
Location of property

Royalties:
Patents, copyrights, etc.

Where property is used

Sale of real property

Location of property

Sale of personal property

Seller’s tax home

Pensions

Where services were performed that earned the pension

U.S. Stock Market & Commodity ProfitsTreated as tax-free foreign source income

Sale of natural resources

Allocation based on fair market value of product at export terminal. For more information, see IRC section 1.863–1(b) of the regulations.

*Exceptions include:
a) Dividends paid by a U.S. corporation are foreign source if the corporation elects the Puerto Rico economic activity credit or possessions tax credit.
b) Part of a dividend paid by a foreign corporation is U.S. source if at least 25% of the corporation’s gross income is effectively connected with a U.S. trade or business for the 3 tax years before the year in which the dividends are declared.

 Tax planning for foreign corporations and non-resident aliens

Tax planning for foreign corporations and non-resident aliens sometimes requires a non-U.S. office to be involved with certain aspect of the international business.  This part is complicated.   You will  need the help of your CPA and attorney.    I suggest that you consider my book to learn the fundamentals.  Amazon has it on sale for $9.50.

Foreign Investors Learn Why a Foreign Corporation is U.S. Death Tax Trap

The problem for the non-resident alien is that their estate tax exemption is $60,000 and not $5.3 million (as it is for Americans).   And there is one more problem… the U.S. estate tax planner.  While the U.S. has a tax on the estate, other countries tax the recipient.  This tax is called an “inheritance tax.”

Thus the  American tax planner also must know “international inheritance tax planning” for the foreign country of the investor.

They advise the nonresident alien (the term for estate and gift taxes is “nondomiciled“) to own their U.S. investments and U.S. real estate through a foreign corporation (such as a Panamanian company or a British Virgin Island company).  

Since the 1950’s, this tax plan has failed.  The U.S. courts have ruled for the IRS (more on these cases on this link).  These court cases focused on the power to revoke (section 2038) and the right to the corporate dividends (section 2036).  These tax laws  required the assets owned by the foreign entity to be included in the deceased’s U.S. taxable estate

The best estate tax planning method for the foreign investor involves a trust.   Here is a link on the basics.  In Europe and the United Kingdom have an inheritance tax.  Estate taxes and inheritance differ.  This difference challenges international inheritance tax planners. 
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Saving Taxes with the Doctrine of Debt versus Equity

Your innovative CPA will use the doctrine of debt versus equity to save you taxes and to protect your assets.   A “doctrine” is a  law created by the courts.    

Great tax planners decide if their client needs the tax savings of a related party debt or equity.  Debt allows income shifting to an entity that has a tax loss or that is taxed at a low rate.  The interest rate on a related party debt can be as low as 1% for short-term debt.

If you would like to brainstorm your tax planning, then please call me, Brian Dooley CPA, at 949-939-3414 for a free one-hour consultation with you and your attorney of CPA.

  This blog explains the doctrine.  With this knowledge, you can work with your innovative CPA.

The doctrine is the subject of many favorable IRS rulings and court cases.  Please, be a prudent taxpayer and obtain an IRS private letter ruling for yourself (more on this link).

This blog looks at a Tax Court victory for a sophisticated cross-border debt by a Pepsi Cola Company and a U.S. District Court victory for a small business.

Pepsi wanted to bring money into the U.S. tax-free.  America’ international tax law has a tax penalty when a domestic company invests their foreign profits in America.   The penalty tax of $363 million was in dispute.  The battle was fought in the Tax Court. Here is a link to the Pepsi case.    Victory depended upon a high tension tax issue in corporate finance and tax law between equity and debt.

Both equity and debt offer certain advantages.   Innovative companies try to have it both ways by devising hybrid securities that look like debt in some circumstances and like equity in others.

Here is what happened. In the 1990s, Pepsi expanded into Eastern Europe and Asia. PepsiCo chose the Netherlands as its home base.  The Dutch tax treaties are the best in the world.

Pepsi recorded the transaction as debt on the financial statements for the Dutch company.  Also, they reported the transaction as debt on the Dutch tax returns.  In the U.S., they treated on the transaction as equity for income tax purposes.

Your tax planning danger is that many CPAs and attorneys believe that a taxpayer is required to pay on the form you use.  This is not the law (if your tax advisor needs help, please have him call me, Brian Dooley, at 949-939-3414 for a free consultation) as you will read in the two cases in this blog.

Tax Court Judge Joseph Goeke wrote a 100-page decision.  He said that Pepsi “engaging in legitimate tax planning,” created an innovative “hybrid securities.”   This means that the security was treated as debt in the Netherlands and under GAAP and equity in the United States for tax planning.  For Pepsi, this created a $363 million tax savings.

PepsiCo successfully argued it had an equity stake in its Dutch subsidiaries.  Pepsi said that the payments made to the U.S. parent corporation were tax-free returns of its capital investment.  The Tax Court agreed.

Now a small business tax case.  In Post Corporation versus United States of America, the Justice Department brought out their Top Gun Attorney, Mr. Carr Ferguson.

This case is has a typical small business bookkeeping goof which the IRS tried to turn into a tax assessment.  The bookkeeper posted the amount of money invested into the business as a loan.  This is common since software such as QuickBooks (which I like), does not have a “paid in capital” or “capital surplus” account.

In this case, there was not a written document or corporate minutes discussing the transactions.  Like most small businesses, the owner puts money into the business when bills must be paid.

When the IRS agent saw the loan account on the tax return, the taxpayer was assessed income tax for imputed interest income.

The doctrine of debt versus equity excludes the issue of bookkeeping postings and the reporting of the transaction on a tax return.   Why?  This would make it too easy for the taxpayer to game the system.  It would also violate the doctrine of substance versus form (also known as economic substance).

Meanwhile, the Department of the Treasury had the IRS issue well-written regulations on the doctrine of debt versus equity (found in section 385).  The Justice Department never had a chance.  The taxpayer cited these regulations and had an easy victory.    On this link, you will find the case with some of my notes.

IRS Publication makes the U.S. a Tax Haven for the U.K. Entrepreneur

America, the Tax Haven  for the U.K. Entrepreneur

We all know that the U.S. is a VAT tax haven.   No VAT means goods and services are only 3/4 of the cost as in the U.K.  The automobile that costs 30,000 pounds is only 22,500 pounds in the U.S.  Everything is cheaper.  

However, the U.S. is also an income tax haven for the U.K. citizen. Continue reading