Tag Archives: permanent establishment

How the IRS Taxes Australian, Candadian, U.K. and Europeans Companies and Citizens Doing Business In The United States

french tax, french tax planning, job loss.

French businesses are profiting by avoiding the VAT by manufacturing in the U.S.

This blog is for Australian, Canadain, U.K. and Western European companies and citizens planning to have a business in the U.S. or business income from U.S. customers.

The United States is courting U.K., Western European, Canadian and Australian citizens to move their businesses.  The U.S. doesn’t  have a VAT (value-added tax).  The absence of this tax gives a 25% increase in a company’s purchasing power (assuming a VAT of 20%) of inventory, machinery, and employees.  Business makes more money due to the additional working capital.   

Labor unions are weak in the U.S. Employee rights are limited compared to the U.K., the EU, and Australia.

This blog explains how citizens (and their companies) from a tax treaty country are taxed in the U.S.

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How to Prepare Form 1120F for a Foreign Corporation’s non-U.S. Business Income and Investment Income & Form 5471

Table of Contents to Foreign Corporation Tax Planning and Preparation for Form 1120F.  For Form 5471, please click on this link.

International tax planning has a thin line between non-business income and business income.

A foreign corporation pays a tax of 30 percent of the amount it receives from sources within the United States as investment income and sometimes compensation:1

The 30 percent tax does not apply to interest income on a “portfolio debt”  that a foreign corporation receives from U.S. sources.

Avoiding U.S. tax on Businesses Income with no Permanent Establishment. 

One part of the Form 1120-F to report and pay tax on U.S. source investment income and U.S. source income from the sale of property (including inventory).  When the foreign corporation does not file the U.S. Form 1120F, the IRS can at any time assess taxes.  The corporation will also lose its right to deduct expenses.

If you are not sure if Form 1120F is required, you can use the safe method of a protective filing.   If you need help, then please call me Brian Dooley, CPA, MBT at 949-939-3414.

International tax planning has a thin line between non-business income and business income.

This thin line decides which of two very different tax laws apply.  This blog is on the income that is not connected to a  U.S. office or “place of business”.

Sometimes this income is investment income and sometimes business income that is not connected to a U.S. business’s office or place of business.

A foreign corporation pays a tax of 30 percent of the amount it receives from sources within the United States as:

(1) interest (other than bank interest),  dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, and royalties,

(2) gains on the disposal of timber, coal or domestic iron ore with a retained economic interest;

(3) gains from the sale or exchange of patents, copyrights, secret processes and formulas, goodwill, trademarks, trade brands, franchises, and other like property, or of any interest in such property but only to the extent the gains are from payments that are contingent on the productivity, use, or disposition of the property or interest sold or exchanged.   The taxable portion is after recovery of your cost; and

(4) and other “fixed or determinable” annual or periodical gains, profits, and income (this is a “catch all” part of the tax law that rarely applies).

The gross income (income before expenses) is taxed a 30 percent.  Sometimes, a tax treaty may reduce this tax rate.

The 30 percent tax does not apply to interest income on a “portfolio debt”  that a foreign corporation receives from U.S. sources.

The purpose of the portfolio debt tax law is to allow the foreign investor to make loans to U.S. persons and avoid U.S. taxes.  Yes, the intent of the law is to avoid taxes.  The following is a summary of the type of debts.

(1) An unregistered obligation that is payable only outside the United States if the obligation is designed to be sold only to a non-U.S. person; and

(2) A registered obligation for which a statement is if the beneficial owner of the obligation is not a U.S. person.

The following types of interest cannot be portfolio debt interest:

(1) Contingent interest, such as interest payments that depend upon the income, profits, or assets of the debtor;

(2) Interest received by a bank on an extension of credit made under a loan agreement entered into in the ordinary course of its trade or business;

(3) Interest received by a 10-percent shareholder of the corporation paying the interest; and

(4) Interest received by a controlled foreign corporation from a related person.[1]

The other advantage is U.S. estate taxes.  Upon the death of a non-resident alien, portfolio debt is not included in his or her U.S. estate tax return.

Avoiding U.S. tax on Businesses Income with no Permanent Establishment.

Tax treaty corporations have a unique advantage.   They can earn U.S. business income and not pay U.S. taxes.

Here are some examples of international tax strategies.

Personal service income to U.S. customers

A British law firm has American customers.  They perform the services outside of the U.S.  However; they have an office in Los Angeles for administration and marketing.  Payments made by their American customers are deposited into a U.S. bank located in Los Angeles.

Their income is not subject to U.S. taxes.  You will note that the law firm has a permanent establishment in the U.S.  They did not try to avoid having a permanent establishment or even a place of business.

The tax planning is the international tax law on service income.  This income is sourced where the individual (or computer as in the example below) is located when the services are provided.

Web services to U.S. customers.

A Swiss business has an app that is used by both American businesses and European businesses.  The customer pays for the app pay watching commercials or by monthly subscription services.  The Swiss company maintains and office in Orange County, California for their American owners and directors.  The Swiss company does it banking in Newport Beach, California, and Geneva.

The Swiss businesses income is not subject to U.S. taxes.  Learn why on this link.

Sale of merchandise to Americans   

Sam, a Canadian citizen, has an investor visa and lives in Malibu, and his office is in the Santa Monica.   He owns a U.K. company that sales paddle boards via a U.K. website.  He is a director of the U.K. company.  He is also the sole shareholder.

The paddles are shipped directly from Canada using Federal Express ground shipping.  Title to the paddle board passes to the customer via the website in Canada. The income of the U.K. company is subject to U.S. taxes.   Sam must file form 5471.

FOOTNOTE

[1] Code Section 881(c).

Amazon Fulfillment International Tax Strategies with a Tax Treaty Corporation

Wow, the speed of change in business is leaving worldwide governments in the dust. From Netflix streaming to Google AdWords, the 21st Century business has many legitimate tax avoidance strategies.

This blog explains U.S. taxation (I should say lack of U.S. taxation) for the foreign corporation doing business via the Amazon fulfillment center (referred to as FBA). At the end of this blog is Amazon’s short video explaining their FBA.

Let me tell you about Sam. He is an entrepreneur. He also is wise. He has a tax team of a CPA and a business attorney.  He does not read a blog like this and then goes out and does his tax planning by himself. This blog gives the concept. But the tax savings are in the legal details that only your attorney and CPA can do for you.

Sam has decided to sell beauty products that he has manufactured in Switzerland to U.S. consumers. He will create a fantastic e-commerce and branding website. He will use Google Adwords as part of his marketing. Sam plans to have no employees.

Sam met with his CPA and attorney. After careful research, they have decided on an Irish company. His tax team explained that his Irish company must create the website, contract with the Swiss manufacturer of the products, pay for the marketing including Google Adwords and be the party to the contract with Amazon FBA.

His tax team informed Sam that he must request an IRS private letter ruling before he starts an international business.  Sam is a smart business person. He knows that working with the IRS is the best way to create wealth.

The Irish company needs a U.S. bank account and credit card processing. Sam’s bank required the Irish company to qualify to do business in the state where the bank is located. Sam and his bank are in Florida. The Irish company registers with the State of Florida.

Okay…now it is time to build the business. The Irish company hires an Irish web design firm to create and host the website. In Ireland, many chartered accountants and law firms provide the registered office. As part of this process, the firm provide directors and their staff to help with the management. The Irish company signs the contracts with Amazon and the Swiss manufacturer.

The beauty products are shipped to the Amazon fulfillment centers, and Amazon does the rest.

Back in Florida, Sam checks up on the operations. He gets fantastic reports from Amazon. He talks to the Irish web consultant about the SEO for his website.  He looks at the Google Adwords dashboard. From time to time, Sam travels to Europe to meet with the Swiss manufacturer of new products and to meet with his team in Ireland.

The Irish company files many tax returns. First, an Irish income tax return (the tax rate is about 12%). Here in the U.S., the IRS gets two returns, a Form 1120F (a foreign corporation income tax return) and a Form 5471 (an information return for controlled foreign corporations).  Sam’s CPA explains the tax treaty to the IRS using form 8833.

The U.S. Irish tax treaty provides that If an Irish company has what is known as a “permanent establishment” in the U.S., it owes tax on its U.S. source income (the sales to its U.S. customers). The definitions of a “permanent establish” are from the 1960’s, and they do not include the concept of a fulfillment center’s contract with the vendor(fn1).    While the Irish Tax Treaty has been updated many times, the updates have been for the exchange of information and the American concept of pass-through entities (such as an S-corporation or a trust).

Your tax team must carefully review the fulfillment center’s contract and compare it to the definition of a permanent establishment in the Tax Treaty.

If you me to review your fulfillment center contract then give me, Brian Dooley, CPA, MBT, a call at 949-939-3414. Tax opinions start as low as $5,000.

Footnote (1)  Treaty Article Five, Paragraph 6 states:  ” An enterprise shall not be deemed to have a permanent establishment in a Contracting State merely because it carries on business in that State through a broker, general commission agent, or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business as independent agents.”

If Sam was using a non-treaty corporation (such as the Isle of Man company) then  pursuant to tax code section 864(c)(5)(A), the office or other fixed place of business of an independent agent will not be attributed to a foreign corporation even if the agent has the authority to negotiate and conclude contracts on behalf of the foreign corporation or maintains as stock of goods from which to fill orders on the foreign corporation’s behalf.    

This is where the tax law is tricky.  The agreement with the fulfillment center must be carefully examined to determine if section 864(c)(5)(A) applies. 

Learn more about permanent establishment vs. fixed place of business, section 864(c)(5)(A)  on this link.  As in all international tax strategies, the company should apply for an IRS ruling before proceeding.  Learn about IRS rulings on this link.

 

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.