Tag Archives: tax treaty planning

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).

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. 

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 states.

The U.S. corporation pays income tax on its worldwide income. The maximum U.S. corporate tax rate is 35% (as of October 2017).   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.

The U.S. tax law wants double taxation on corporate profits.  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.   

Cost Sharing Agreements to shift profits

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 cause 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. death tax.

 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.

 

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 establishment” 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.

Get a tax study for your business from us.  We will look at your business and provide you with a tax study for only  (USD) $1,000.  We accept credit cards and wire transfers.  Email me, Brian Dooley, CPA. MBT at [email protected] to get started. 

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.

 

Saving International Taxes with Tax Treaty’s Tie Breaker Rules for the Green Card Holder

Last tax season, I  was busy with many callers asking “I have a green card.  May I be a non-resident for U.S. income taxes under a tax treaty and obtain benefits under the tax treaty?”

A green card holder is a U.S. income tax resident if he or she is not a citizen of a country with a tax treaty.
A green card holder who is a citizen of a country with a tax treaty may be a U.S. income tax non-resident.  Tax treaties override the U.S. tax code.

As a non-tax resident, you live and work in the U.S. but only pay tax on your U.S. income and not your foreign income.

Here is what happens:  If you are a dual-resident taxpayer (a resident of both the United States and another country), a tax treaty’s “tie-breaker” rule determine if you are a U.S. income tax resident.   

Continue reading

Getting the Best of Both Worlds – International Tax Planning for S Corporations and their Alien Shareholders

Dual residents are citizens of nations that have a tax treaty with the U.S.  Most tax treaties have a “tie-breaker” rule that favors the country of citizenship.  

International Tax Planning for S Corporations and their Alien Shareholders – Getting the Best of two tax Worlds

Okay, here is the general rule. A general rule is that dual resident residents are treated as U.S. residents for purposes.  This link provides an IRS legal memorandum on the topic of the dual resident process.    For tax planning, the dual resident will use its home country tax treaty to elect to be a non-resident alien.  This way, he is not paying U.S. tax on his worldwide income. 

Dual residents are often shareholders of S corporation. Here the dual resident international tax planning needs to be cautious.

Until recently, the  IRS regulations provide that if a dual resident taxpayer is a shareholder in an S corporation and the alien claims a treaty benefit as a non-resident alien, the taxpayer is a non-resident alien for the S corporation’s rules.  As a result, the entity’s S corporation election will be terminated.[2]

Most tax planners will tell you that this continues to be the law.   If they do, then you know that you have the wrong international tax planner.

The dual resident alien usually wants to elect to be a non-resident alien.   The tax savings are huge.  For example, no self-employment tax, no controlled foreign corporation tax, no tax on foreign income, no passive income tax, no tax on U.S. bank income and no tax on gains on the U.S. stock market.  Yes, all of this is tax-free.

But here is the problem.  How to invest into a U.S. business.  The easiest is to invest using a domestic limited liability company.   But for the dual resident, his/her home country may not recognize the LLC for asset protection. Thus, why you are protected in the U.S., you are not protected outside the U.S.  The alternative is a corporation. A subchapter S corporation allows a single tax structure.

The IRS issued Treasury Decision 8733 provides that a  dual resident is allowed the best of both tax worlds.   First, he/she remains a non-resident alien legally avoiding the taxes mentioned above.

Next, the dual resident alien can elect to pay U.S. income tax on the S-corporation’s income as if the income was U.S. business income.  If he does, he is an allowed to be a shareholder of the corporation.

For example, the S-corporation is a retail store.  Mr. Wilson a U.K. citizen and a dual resident is a shareholder.  He has not elected to be U.S. resident.  However, he has elected to follow the IRS rules in Treasury Decision 8733.   The S-corporation also earns interest income on its bank deposits.  Mr. Wilson earned $100,000 investing in the U.S. stock market.

The income from the store and the interest income are taxable as business income.  However, the dual resident alien continues to avoid self-employment tax.   The $100,000 gain in the stock market is not taxable by the IRS. 

The IRS  Treasury Decision 8733    states “under section 7701(b) provide that for purposes of determining the U.S. income tax liability of a dual-status alien who is a shareholder of an S corporation, the trade or business or permanent establishment of the S corporation shall be passed through to the dual status alien pursuant to section 1366(b).”

Here is what is happening. The taxpayer and the S corporation entering into an agreement to be subject to tax and withholding as if the dual resident were a non-resident alien partner in a partnership.  This means that the S-corporation withholds tax on his share of the income.  The tax is withheld at the highest tax rate.  This tax is refundable when the dual resident alien files his income tax return.

If the dual resident taxpayer does this then:
1.  the character and source of the S corporation items included in the dual resident shareholder’s income are determined as if realized by the shareholder and
2. the dual resident shareholder is considered as carrying on a business within the United States through a permanent establishment if the S corporation carries on such a business.[4]

This exception is not available if the S corporation was a C corporation[5]

Special IRS reporting: A dual resident taxpayer who is an S corporation shareholder must:
1. comply with the filing requirements and
2  must include an additional declaration indicating that he understands that claiming a treaty benefit as a non-resident will terminate the S corporation’s election unless the exception applies. [6]   IRS Form 8833, Treaty-Based Return Position Disclosure (under Section 6114 or 7701(b)) is required if the payments or income items reportable because of that determination are more than $100,000.

By the way, this blog article is the only article on this topic.  It represents on of the many innovations international tax plans found only in my book, International Tax Planning in America for the Entrepreneur, on this link.  You will learn many tried and true tax plans that no one else knows.

We recommend that you work with the IRS and get their okay of your tax plan with a private letter ruling (get more information on this link).

[1] Warning:  The regulations 301.7701(b)- 7(b).  state that the filing of a Form 1040NR by the dual resident taxpayer may affect the determination by the Immigration and Naturalization Service as to whether the individual qualifies to maintain a residency permit.

[2] Regulation 301.7701(b)-7(a)(4)(iii).

[3] Regulation 301.7701(b)-7(a)(4)(ii).

[4]  Regulation 301.7701(b)-7(a)(4)(iv).

[5]  Regulation 301.7701(b)- 7(a)(4)(iv).

[6] Regulation 301.7701(b)-7(c)(3). In part 10 FSA (field service advice) 1992-50 states   “[10]  A dual resident taxpayer who is assigned residence to the treaty partner’s country and claims to be treated as a resident of that country will be treated as a nonresident of the United States solely for purposes of computing their U.S. income tax liability. For purposes other than the computation of their U.S. income tax liability, the individual will be treated as a U.S. resident under the Internal Revenue Code. To take advantage of the treaty “tie- breaker” rule exception, a dual resident taxpayer must timely file a completed Form 1040NR tax return with a statement in the form required by section 301.7701(b)-7(c) of the regulations, attached to the return. The filing of a Form 1040NR with the attached statement is required under section 301.7701(b)-7(b) whether or not the individual has any income subject to U.S. tax.”