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Form 1120-F (U.S. Income Tax Return of a Foreign Corporation) covers three different taxes. Saving International Taxes Requires an International Tax Accountant.

Table of Contents

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.

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 just give me, Brian Dooley, CPA, MBT a call at 949-939-3414. 

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).

Avoiding the Form 1120F- Foreign Corporation Branch Profits Tax Trap

Preparing the Branch Profits Tax section of the IRS form 1120F  has trapped many foreign investors in U.S. real estate and with US business operations.

 In addition to paying income tax on your profit, the foreign corporation pays tax again on the change in the value of its U.S. business. 

The branch profits tax is based upon a law from the 1950’s. The section 531, tax on accumulated earnings, was deadly to a small business.  However, now most small businesses operate in S-corporations or limited liability company. Since entities of this type are pass through, avoid section 531 does not apply.   Because of this many tax professionals are unaware of this law.

The branch profits tax is just as deadly to the foreign business.  This tax applies if the foreign corporation has income effectively connected with a U.S. business. The applies if the corporation has either a permanent establishment of a fixed place of business.

 If you want help preparing your Form 1120F, then call me Brian Dooley, CPA, MBT at 949-939-3414.

Some CPA’s are advising their clients that keeping assets on the American branch office balance sheet avoids the branch profits tax.    Just holding assets on the books,  does prevent the branch profits tax.  The assets must be continued to be used in an active corporate business.

Section 531 (a tax on accumulated distribution) is the concept used when the branch profit tax was enacted.  Under this section, the corporation must prove the business reason for keeping liquid assets.   The point of section 531 is to cause the second tax.  This is a tax on a dividend that the corporation has refused to distribute.

Likewise, the IRS can impose the branch profits tax when a foreign corporation with a US branch merely retains liquid assets just to avoid the tax.   

Upon a distribution of property to the shareholder of a foreign corporation, the 30 percent branch profits tax apply.  Similar to section 531, corporation needs to maintain ongoing director minutes, shareholder minutes and business plans explaining why assets are not distributed to the shareholder or the home office.

Learn about winning the IRS audit of the branch profits tax on this link.   On this link, find out more innovative methods to eliminate both the branch profits tax and foreign corporation income tax on this link.   If you need help with an international tax audit, then contact me at [email protected]

tax planning, international tax strategies, foreign tax strategies, foreign tax plan, international tax plan, offshore tax,

Learn how to save taxes with “International Taxation in America for the Entrepreneur” using tried and true methods.

If you would like to us to prepare your Form 1120F,  then please call me, Brian Dooley CPA, at 949-939-3414.  

Learn move about international tax planning with my easy to read book, International Taxation in America for the Entrepreneur available at Amazon on this link.  The book takes about two hours to read.

 

 

International Tax CPA Accountant for Preparation of Form 1120F

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Get an international tax expert and pay the least in taxes with your Form 1120F.

Brian Dooley, CPA, MBT is an expert in international tax.  Your foreign corporate income tax return has three parts.  Each part is independent and has its own international tax laws.

Brian is the leading specialist in the branch profits tax and effectively connected income tax accounting.  His book, International Taxation in America is a textbook on issues such as permanent establishments in the United States by a foreign corporation.

Give Brian a call at 949-939-3414 and discuss your tax concerns. Brian is located in Orange County, California.

He truly is an expert, He testifies at the Department of U.S.Treasury, the Congress and the U.S. Senate.   He is an instructor for the California Society of CPAS and the Graduate tax  Program for the California State University System.

 

Minimizing or Eliminating the Branch Profits Tax and Reducing U.S. Taxable Income for the Foreign Corporation

This blog is a subpage  “Avoiding the Form 1120F- Foreign Corporation Branch Profits Tax Trap”  on this link.

At thirty percent, the branch profits tax worth avoiding.  There are some options foreign corporations use for minimizing or eliminating the branch profits tax and U.S. corporate income taxes.  They are:

(1) Increase salaries and bonuses within the reasonable compensation rule limit to the shareholders/employee.  To the extent they work outside the U.S., the salary is exempt from U.S. taxation.

(2) Provide more fringe benefits (e.g., a qualified pension plan). The plan can be a domestic plan or a foreign plan.  Certain tax savings are available if the plan is funded with assets in a foreign trust.

(3) Have the corporation pay a “stewardship fee” to the home office. A “stewardship fee” is a payment for the benefit provided by the home office[1].

(5) Pay dividends, including, perhaps, a consent dividend.

(6) Redeem stock, using a deferred payment obligation as consideration. Accumulating money to pay for a redemption is not considered a valid purpose for accumulating earnings but redeeming now and paying off the debt later is permissible.[2]

(7) Establish a qualified pension plan. A resulting unfunded pension liability should reduce unreasonable accumulations.  The plan can be within the U.S. or outside the U.S. If many of the  U.S. branch employees are not U.S. citizen, the foreign pension plan will have an advantage in the long run.

(8) Recapitalize the corporation to shift dividends to selected shareholders such as those residing in a treaty partner country.

(9) Buy business assets instead of leasing them.

If you want to increase the quality of your tax planning, then email me, Brian Dooley, CPA, MBT, at brian@intltaxcounselors.com.

Footnotes:

[1] The following is from an IRS web page: Foreign Corporations (FC) may operate in and earn taxable income in multiple jurisdictions including the U.S. In the case of an FC operating in the U.S. through a formal or de facto branch, the FC is required to file a Form 1120-F, U.S. Income Tax Return of a Foreign Corporation, and may have a U.S. tax liability.

The FC is required to calculate its taxable income and report the earnings of the U.S. branch (USB) that are effectively connected with the conduct of a Trade or Business within the U.S (Effectively Connected Income, or ECI). As part of this calculation of ECI, the U.S. branch is allowed to deduct expenses associated with the earning of such income. The amount of expenses related to the ECI is generally deductible in the calculation of ECI based on normal domestic principles such as “reasonable” and “ordinary and necessary.”

Taxpayers should report total expenses that are related to ECI on line 11, Part I, and line 39(a), Part IV, of Schedule H (Form 1120-F). Indirect expenses, such as those expenses incurred by the foreign headquarters, or a brother-sister branch, on behalf of the U.S. branch, and related to the trade or business of the U.S. branch in earning its ECI, may also be deductible in part, or possibly, in whole. It is necessary that the FC make an allocation and apportionment to the U.S. branch of these types of expenses to clearly reflect ECI.

The methods and principles of Treas. Reg. Secs.1.861-8 through 1.861-17, 1.861-8 through 1.861-14T, and 1.882-5 ( the 861 and 882-5 regulations), as well as the general rules for deductibility as stated above, apply. In general, the regulations require that deductions be allocated to gross income based on a reasonably close factual relationship. Taxpayers should report total indirect expenses apportioned to ECI on line 16, Part II, and line 40(a), Part IV of Schedule H (Form 1120-F).

This means that in earning gross income of a particular type or class, certain expenses may be necessary. The deductions resulting from such expenditures are allocated and apportioned to such gross income to the extent that a reasonably close factual relationship exists. As always, the resulting taxable income must be clearly reflected.

[2] 6/ Mountain State Steel Foundries, Inc. v. Commissioner, 284 F.2d  737 (4th Cir. 1960); C.E. Hooper, Inc. v. Commissioner, 539 F.2d 1276  (Ct. Cl. 1976).

 

Foreign Corporate Tax Planning for the Branch Profits Tax

A successful foreign corporation doing business in the U.S is taxed a second time.  The tax is called the branch profits tax.   

A U.S. business includes real estate, investments in a domestic (American) limited liability company or partnership, manufacturing, retail, distribution and providing services.

With a rate of up to thirty percent (less if the corporation is taxable in a tax treaty country), the successful business wants to minimize or eliminating the branch profits tax.  The tax is reported on Form 1120F.

The Problem:  The Hidden Branch Profits Tax Trap

This tax applies when the foreign corporation has accumulated profits beyond the needs of its active business.  The theory of the branch profits tax is similar to the accumulated earnings and profits tax that applies to a domestic corporation.   This domestic tax has applied to domestic C corporations for more than half a century.  Thus, the tax planning, below, is based upon the tax court cases regarding the domestic tax.

For example,  In 2000, a foreign corporation invests $2,000,0000 of cash into a partnership that owns commercial rental property in the U.S.   The partnership is successful and has distributed profits each year of $100,000. The U.S. and state income tax are $40,000. The net cash after tax is $60,000. After 15 years the $ 60,000 annually plus the investment income has grown to $1,000,000.

The foreign corporation has kept the money in U.S. banks and the  U.S. stock market.   These assets are not used in the foreign corporation business, that of being a partner.

The IRS audit the foreign corporation and successfully assessed the branch profits tax.  The foreign corporation owes $300,000 in tax and a $60,000 penalty for reporting the tax.

How to avoid the branch profits tax

Here are few tried and true methods that have been used by U.S. corporations to prevent a similar tax known as “the accumulated earnings tax.”

By the way, merely keeping the profits in U.S bank accounts or investments does not avoid the tax unless you can prove the funds are necessary for the business activities.  Below are some business activities that have been accepted by the courts.

(1) Convert the business arrangement into a non-corporate structure.  The most popular is a combination of a Nevada trust with a Nevada single member limited liability company.   Since many corporations do not know what their earnings and profits are, the corporation’s earnings and profits should be calculated before deciding whether the conversion is a good idea.

(2) Increase salaries within the reasonable compensation rule limits.  Avoid issuing bonuses since the tax court often sees a bonus as a non-deductible and taxable dividend.

(3) Provide more fringe benefits (e.g., a qualified pension plan).

(4) Have the corporation invest in securities generating capital gains.  Since the accumulated earnings tax only falls on taxable income, the corporation should invest in securities, the sale of which generates capital gains.

(5) Redeem stock, using a deferred payment obligation as   Consideration.  Accumulating money to pay for a redemption is not considered a valid purpose for accumulating earnings but redeeming now and paying off the debt later is permissible.[1]

(6) Establish a qualified pension plan.  A resulting unfunded pension liability should reduce unreasonable accumulations.

(7) Recapitalize the corporation to shift dividends to selected shareholders.

(8) Buy business assets instead of leasing them.

(9) Most important!   Keep corporate minutes.  Do the minutes within a reasonable time after the meeting of the board of directors of the corporations.  These minutes must prove the business reason for the corporation retaining its profits.  The eight items above are examples of business reasons. 

If you want to increase the quality of your tax planning, then email me, Brian Dooley, CPA, MBT, at brian@intltaxcounselors.com.

Footnote:

[1] Mountain State Steel Foundries, Inc. v. Commissioner, 284 F.2d  737 (4th Cir. 1960); C.E. Hooper, Inc. v. Commissioner, 539 F.2d 1276  (Ct. Cl. 1976).