international tax bootcamp - level i · current year, 1/3 of the days present in the first...

WithumSmith+Brown, PC |

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International Tax Bootcamp -Level I

Chaya Siegfried

Michael Fleisher


1

Overview

1. General Principles

2. Residency

3. Source of Income Rules

4. FDAP Income

5. Withholding Under §§1441 & 1442

6. Effectively Connected Income (ECI)

7. Branch Profits Tax

8. FIRPTA

9. Foreign Tax Credits


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GENERAL PRINCIPLES


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General Principles

U.S. Persons

• Subject to U.S. income tax on their worldwide income

Foreign Persons

• Generally subject to U.S. income tax only on certain U.S. source income


4

RESIDENCY RULES


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Residency

▪ An individual is a resident for all federal tax purposes for a particular year if the individual:

• is a “lawful permanent resident

• meets the “substantial presence test” for the year, or

• qualifies for and makes the “first year election” for the year. (§ 7701(b)(1))


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Residency – Substantial Presence

▪ An individual meets the substantial presence test if • They are present in the US for 183 in a particular

year• They are present in the US for 31 days in the current

year and the total of all the days present in the current year, 1/3 of the days present in the first preceding year and 1/6 of the days present in the second year equal 183.

▪ Exceptions apply if closer connection, individual is present on certain exempt visas or treaty provision applies.


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Case Study #1

Louis is a U.S. citizen who has lived in France for the last 20 years. Is Louis subject to tax on the regular salary he earns in France? On the dividends he earned from a Hong Kong company’s stock which he purchased on the London stock exchange?


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Polling Question #1


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Case Study #2

▪ Harold is a citizen of Hong Kong but travels from country to country. Harold was present in the U.S. for various periods of time. For each of the following determine what year, if any, will Harold be treated as a U.S. tax resident? • Harold was present in

the U.S. for 330 days in 2014, 330 days in 2015, and 30 days in 2016


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Residency

▪ A corporation/partnership is considered “domestic” or a resident if it is created or organized in the United States (50 states or D.C.). (§7701(a)(4)) or elect under §1504(d)

▪ Trust is considered “domestic” if the trust instrument is governed by a US court andmajority of the trustees are US indiviuals


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Case Study #3

▪ ABC Partnership is a Delaware partnership it is owned 50% by a Mexican national and 50% by an Argentinian national. Neither partner has ever been in the U.S. nor are they citizens of the U.S. is ABC Partnership a U.S. or foreign partnership?


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Case Study #4

123 Inc. is a corporation organized under the laws of Peurto Rico is this a U.S. corporation?


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Polling Question #2


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Expatriates – Post June 17, 2008

Section 877A.

• Imposes a one-time mark-to-market tax on the net unrealized gain on the property of a “covered expatriate”.


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Expatriate

▪ individual who relinquishes citizenship

▪ Individual who ceases to be resident if they were tax residents for 8 of the 15 years ending with their year as taxable resident


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Covered Expatriate

▪ Individuals annual income exceed $124,000

▪ Individual’s net worth exceeds $2M on date of expatriation


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INCOME SOURCING RULES


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Interest – General Residence Rule

General rule –Interest is generally sourced by the residence of the obligor. Section 861(a)(1)

• U.S. Source Interest – interest paid by a U.S. resident.

• Foreign Source Interest – Other interest is generally foreign source.


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Dividends – Place of Incorporation Rule

General Rule – look to the place of incorporation §861(a)(2)

• U.S. Source = dividends from domestic corporations (place of incorporation).

• Foreign Source = dividends from foreign corporations.

• Exceptions


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Services Income

General Rule –compensation for labor or personal services is U.S. or foreign source based on where the services are performed §861(a)(3)

• The residence of the payor, the place in which the contract for service was made, or the place or time of payment, are irrelevant factors.


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Rents & Royalties

General Rules - §§861(a)(4) and 862(a)(4).

• Rental income is U.S. or foreign sourced based on the location of the property(real property) or place of use (personal property).

• Royalties is sourced by the place of use of the intangible property.


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Sale of Real Property

▪ Income from the sale of real property is U.S. or foreign source income based on the location of the property. (§§861(a)(5) and 862(a)(5))


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Sale of Personal Property

General Rule -§865(a) –

• Income recognized from the sale of personal property generally is U.S. or foreign source based on the residence of the seller.

Exceptions

• Inventory Property Rules

• Intangibles


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Inventory Property – Title Passage Rule

▪ Income derived from the purchase and resale of inventory is sourced at the place of sale.

Exceptions:

• Income from the manufacture and sale of inventory produced/manufactured in the U.S. sourced to U.S.


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Software Sourcing Rules

Four categories of software transfers:• The transfer of a “copyright right” in a computer

program is either a Sale or a License (royalty income)

• A transfer of a copy of the computer program is either a Sale or a Lease (rental income)

• The provision of services for the development or modification of the computer program.

• The provision of know-how relating to computer programming techniques.


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Cloud & Other Digital Content Transactions

Two categories of Income:

• Services

• Lease


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Case Study #5

• Able, an individual, borrowed $100,000 from Baker an Albanian citizen and resident. Able was a citizen and resident of Albania at the time he borrowed the money. Able subsequently moved to the U.S. and is now a U.S. resident and citizen. All of Able’s income is derived from his wages earned in the U.S. Able pays $5,000 in interest to Baker. How is the interest income to Baker Sourced?


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Polling Question #3


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Case Study #6

▪ XYZ is a California corporation owned equally by 3 shareholders, all of whom are citizens and residents of Hong Kong. In 2016 XYZ made a cash distribution to its shareholders of $1,000,000. What is the source of the shareholders dividend income ifXYZ has $10,000,000 of current earnings and profits for 2019?


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Case Study #7

▪ XYZ is a California corporation owned equally by 3 shareholders, all of whom are citizens and residents of Hong Kong. In 2016 XYZ made a cash distribution to its shareholders of $1,000,000. What is the source of the shareholders dividend income ifXYZ has $0 of current or accumulated earnings and profits as of December 31, 2019?


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Case Study #8

James is non-resident and a 10% partner in partners PRS LLC (a US partnership), which invests in European stock markets. In Year 1, PRS earns $200,000 of portfolio dividend income from foreign corporations and $300,000 in capital gains from sales of stock of foreign corporations. What is the amount and source of James’ distributive share of partnership income in Year 1?


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Case Study #9

James is non-resident and a 10% partner in partners PRS LLC (a US partnership), which invests in the stock markets. In Year 1, PRS earns $200,000 of portfolio dividend income from U.S. corporations and $300,000 in capital gains from sales of stock of foreign corporations. What is the amount and source of James’ distributive share of partnership income in Year 1?


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Case Study #10

James is a US green card holder and a 10% partner in partners PRS LLC (a US partnership), which invests in European stock markets. In Year 1, PRS earns $200,000 of portfolio dividend income from foreign corporations and $300,000 in capital gains from sales of stock of foreign corporations. What is the amount and source of James’ distributive share of partnership income in Year 1?


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Case Study #11

Mechanix a Delaware corporation sells, automotive tools. Determine the source of Mechanix’s if Mechanix purchases the tools from a US manufacturer and resells them at a markup to Japanese customers title passage upon receipt by the customer?


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Case Study #12

X is a nonresident alien employed by a Chinese corporation. During 2019 X’s Chinese employer sent her to the United States to investigate the possibility of opening an office in the US. She arrived in the US at 8PM on January 1, 2019 and departed at 4PM on April 2, 2019. She did not spend any other time in the US in 2019. While in the US she earned $2,900. Her employer also reimbursed her $600 for her actual travel expenses. What is the source of X’s income earned in the US?


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Polling Question #4


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Case Study #13

WeKnowValue, a domestic corporation based in Massachusetts that performs valuation services, was hired for $200,000 to advise a client on a potential corporate acquisition. The target company was a French corporation with a US subsidiary. In order to value the target company, WKV sent its employees to France and California to review the target’s books and records. The same team spent 40% of their time in California and 60% of their time in France. What is the source of the fees for this engagement?


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Case Study #14

▪ Enrico Pennetta is an Italian inventor who lives and works in Milan. In Year 1 Enrico had an idea for a scientific discovery relating to lasers but required substantial funding for research, development and testing. Enrico entered into an agreement with Prima Industrie S.p.A. a leading Italian Industrial firm, whereby Prima agreed to fund Enrico’s research in exchange for the exclusive commercial rights to any inventions arising out of Enrico’s work. Prima also agreed to pay Enrico a 5% “royalty” on all revenues it earned in respect of products incorporating Enrico’s inventions. In year 6, Prima earned $16 million in royalties from four US companies in nonexclusive US licensing rights to such products. Under their agreement, Prima paid Enrico $800,000, 5% of the $16million of revenues that it earned.

What is the source of Prima’s $16 million of royalty income?


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Polling Question #5


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Case Study #15

Enrico Pennetta is an Italian inventor who lives and works in Milan. In Year 1 Enrico had an idea for a scientific discovery relating to lasers but required substantial funding for research, development and testing. Enrico entered into an agreement with Prima Industrie S.p.A. a leading Italian Industrial firm, whereby Prima agreed to fund Enrico’s research in exchange for the exclusive commercial rights to any inventions arising out of Enrico’s work. Prima also agreed to pay Enrico a 5% “royalty” on all revenues it earned in respect of products incorporating Enrico’s inventions. In year 6, Prima earned $16 million in royalties from four US companies in nonexclusive US licensing rights to such products. Under their agreement, Prima paid Enrico $800,000, 5% of the $16million of revenues that it earned.What is the proper characterization of Enrico’s $800,000 if income? What is its source?


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Case Study #16

Gamerco, a US corporation, develops and markets computer gaming software. All of its engineers are located in the US. Once the software is ready for sale, the final version (the “golden master”) is sent to a disc duplicator in Texas to make 10,000 copies. The CDs are then boxed with the manual, shrink-wrapped, and sold to foreign customers with the license rights transferring to the customer when it breaks the shrink-wrap and thereby agrees to the license terms. Under the license terms the customer has the right to use the software on not more than two physical computers, and may not copy, distribute, publicly display, reverse engineer, or otherwise modify the software. Determine the nature of Gamerco’s income if the software is transferred to the customer under a perpetual license?


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Case Study #17• Gamerco, a US corporation, develops and

markets computer gaming software. All of its engineers are located in the US. Once the software is ready for sale, the final version (the “golden master”) is sent to a disc duplicator in Texas to make 10,000 copies. The CDs are then boxed with the manual, shrink-wrapped, and sold to foreign customers with the license rights transferring to the customer when it breaks the shrink-wrap and thereby agrees to the license terms. Under the license terms the customer has the right to use the software on not more than two physical computers, and may not copy, distribute, publicly display, reverse engineer, or otherwise modify the software. Determine the nature of Gamerco’s The software if transferred to the customer under a license with a term of 1 year. After 1 year, the customer may renew the license by paying another year’s fee. If a customer chooses not to renew, a license key built into the software will cause it to stop working at the end of the 1-year term.


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Polling Question #6


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FDAP & WITHHOLDING


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Fixed, Determinable, Annual, or Periodic (FDAP) Income

▪ Non-residents are subject to U.S. tax on their U.S. source FDAP income

▪ 30% tax on U.S.-sourced fixed or determinable annual or periodical income (FDAPI).


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Fixed, Determinable, Annual, or Periodic (FDAP) Income

FDAP income includes:

• Interest

• Dividends

• Rents

• Royalties

• Services

• Wages


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Withholding Tax §§1441 & 1442

▪ The withholding agent must withhold 30% tax on any payment of US source FDAPunless the rate is reduced by a treaty.

▪ The withholding agent is liable to pay the tax if it fails to withhold.


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Who is a Withholding Agent?

▪ Any U.S. or foreign person that has control, receipt, custody, disposal, or payment of any item of income of a foreign person that is subject to withholding.

▪ Generally, the U.S. person who pays an amount subject to NRA withholding is the person responsible for withholding.

▪ The withholding agent is liable to pay the tax if it fails to withhold.


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Polling Question #7


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Who is a Withholding Agent?

▪ Any taxpayer making direct payment of US source FDAP to foreign person

▪ Partnership with foreign partners allocating FDAP income to foreign partners

▪ US taxpayer acting as agent collecting US source FDAP on behalf of non-US person


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Portfolio Interest Exception

▪ Most portfolio interest is exempt from withholding

▪ To Qualify certain language must be present in loan documentation

▪ Not applicable to interest from 10% or more shareholder


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Tax Treaties

A Tax Treaty:

• Governs when and how countries can tax residents of treaty partners

• Primary Application

Reduce withholding rate on FDAPI

Permanent Establishment

• Qualified Resident

• Limitation on Benefits Clause


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Tax Treaties – general guidance

Interest – typically withholding is eliminated or reduced across the board however does not apply to contingent interest

Dividend – typically two rates and lower for 10% or more corporate shareholders

Royalties – typically withholding is eliminated or reduced provides a definition for which royalties are covered


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Tax Treaties – general guidance

Rent – typically not covered in treaty


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Tax Treaties – Limitation on Benefits

• Qualified Resident –

defines which residents qualify for the treaty benefits

Typically includes tie-breaker provision

• Limitation on Benefits Clause

To prevent treaty shopping


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Withholding Agent – What now?

▪ Must collect withholding documentation

• Either W-9 for US taxpayer or W-8

W-8BEN – for non resident invidual

W-8BEN-E for non-resident entity

W-8IMY- for non-resident intermediary

▪ Must review withholding documentation for reasonableness

▪ Withholding documentation must match payee


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Polling Question #8


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FATCA Withholding §1471

▪ Transparency regime which piggybacks on §1441 & 1442 but far more onerous

▪ Distinction from §1441 & 1442 if you can substantiate ownership no withholding required

▪ Income may be exempt from withholding under FATCA if UBO is documented but still subject to withholding under §1441 & 1442

▪ Withholding on additional types of income not just FDAP

▪ More due diligence required on the part of the withholding agent with respect to the payee

▪ 30% penalty tax not reduced by any treaty


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Case Study #18

▪ Alpha Inc. a U.S. corporation, has the following shareholders Sam a U.S. individual (40%), ForAlpha Inc. a Canadian corporation (8%), Tim a Hong Kong individual (30%) and Alpha LP a UK Partnership (22%). Alpha Inc has $500,000 of income for 2019 and makes a distribution of $250,000 pro –rata to its shareholders. Alpha Inc also has a loan from ForAlpha and paid $30,000 of interest on that loan to ForAlpha during 2016. Alpha also has an agreement with Tim to exclusively exploit a patent that he owns in the AsiaPac for 10% of the gross revenues the revenues for 2019 were $1,000,000.

• For each shareholder, what are the documentation requirements, form requirements, & tax withholding requirements (including rates and how you selected this rate) with respect to the

Distribution of $250,000

Interest of $30,000

Royalty payment of $100,000


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Case Study #19

ABC LLC ,a US partnership has five foreign partners and five U.S. partners. During 2019 ABC received interest income on a note with a U.S. note holder. ABC also received dividends from its investment in GE. What are ABC’s tax compliance requirements with respect to these two income streams ?


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Polling Question #9


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Case Study #20

▪ Sas Inc. has developed a cloud based service and hires Jim and Joe to provide development services. Jim and Joe both reside in Romania. Jim provides all development services from his “home office”. Joe comes into the US for about 4 weeks each year to provide development services.

▪ What are Sas Inc.’s responsibilities with respect to payments it makes to Jim? Payments to payments to joe?


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Case Study #21

▪ What is the responsibility of the withholding agent if no documentation is received and it is possible that the recipient/payee is a US person?


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Case Study #22

▪ You are the CFO for Fire Inc. Fire Inc. has a loan from a private lender Jack that when asked provided a W-8BEN and not as you expected a W-9. Furthermore the W-8BEN has a U.S. address. You paid Jack $100,000 of interest income during 2019. The W-8BEN claims Jack is a UK resident and therefore no withholding on the interest payment to him. Can you rely on this W-8BEN?


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EFFECTIVELY CONNECTED INCOME


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Effectively Connected Income (ECI)

Overview of ECI.

• Nonresident aliens and foreign corporations are taxed under §§871(b) and 882(a) at graduated rates on taxable income effectively connected with a US trade or business (“ECI”).

Two fundamental concepts:

• Must be “engaged in a US trade or business;” and

• The income is “effectively connected” with that trade or business.


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U.S. Trade or Business

“U.S. trade or business” is not specifically defined in the Code or the regulations.

• Case law is relevant.

• Cases generally look to activities that are “regular, substantial, and continuous.”


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Personal Services.

• Generally, performance of personal services within the United States at any time is a US trade or business.

• Section 864(b)(1) provides a de minimis rule which provides some limited relief.


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Agents.

• Foreign persons could be considered to be engaged in a Trade or Business in the U.S. through a dependent agent if the agent has the authority to negotiate and conclude contracts.


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Case Study #23

▪ Bluepan Ltd a Hong Kong company sells smart pans it has a subsidiary in the US that solicits sales in the US. The subsidiary does not have the authority to conclude contracts is Bluepan Ltd engaged in a trade or business in the US?


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Polling Question #10


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Case Study #23

▪ Bluepan Ltd a Hong Kong company sells smart pans it has a subsidiary in the US that solicits sales in the US. The subsidiary does not have the authority to conclude contracts in the US however they typically negotiate the terms of the contract and Bluepan Ltd rubber stamps the deal. is Bluepan Ltd engaged in a trade or business in the US?


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Partnerships.

• Under §875(1), a foreign person that is a partner in a partnership, whether domestic or foreign, is engaged in a US trade or business if the partnership is engaged in a US trade or business.


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Withholding Under Section 1446

Withholding tax on Foreign Partner’s Share of ECI

• If a partnership has ECI under Section 1446 it must withhold taxes on any ECI that is allocable to foreign partners.

• Rate - the rate to withhold at is the highest tax rate applicable to the specific taxpayer type.

• The partnership must withhold and remit the tax on a quarterly basis.


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Withholding Under Section 1446(f)

Withholding tax on Foreign Partner upon disposition of interest in partnership

• If partnership generates ECI

• 10% withholding


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Impact of Treaty - Permanent Establishment

▪ If recipient is resident of treaty country the concept of PE applies

▪ Higher threshold of activities required to reach a PE

Leve

l of

Act

ivit

y

Permanent Establishment

US Trade Or business

C Ltd

B Ltd

A Ltd


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▪ Under treaty business income is only subject to US tax if there is a Permanent Establishment in the US


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Impact of Treaty - Permanent Establishment▪ Definition of PE is a bit more specific see Article V of treaty

• (a) a place of management;• (b) a branch;• (c) an office;• (d) a factory;• (e) a workshop;• (f) a mine, an oil or gas well, a quarry or any other place of

extraction of natural resources;• (g) an agricultural, pastoral or forestry property;• (h) a building site or construction, assembly or installation project

which exists for more than 9 months; and• (i) an installation, drilling rig or ship that, for an aggregate period of

at least 6 months in any 24 month period, is used by an enterprise of one of the Contracting States in the other Contracting State for dredging or for or in connection with the exploration or exploitation of natural resources of the sea-bed and subsoil.


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▪ PE does not usually include

• Ancillary activities that don’t drive business

• Storing of inventory


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Form 1120-F Protective Filing

▪ Retain the right to take deductions and credits

▪ Starts the statute of limitations


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BRANCH PROFITS TAX


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Branch Profits Tax

UK Parentco

US Subco

UK Parentco

US Branch

Subject to tax on ECI?

Subject to withholding tax on dividends?

So why incorporate in the U.S.?


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Branch Profits Tax §884

The Purpose.• The branch profits tax is, in effect, a substitute

for the withholding tax on dividends paid by a domestic subsidiary to its foreign corporate parent.

• This tax is in addition to the ECI tax under section 882.

• Branch profits tax is calculated and paid on the Form 1120-F

• The branch profits tax of 30% is imposed on the “dividend equivalent amount.”


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Case Study #24

▪ Worldwide, a U.K. public limited company, acquires U.S. assets of GetItRight a US entity. Worldwide operates the business directly. The US business consists of IT outsourcing services to large companies within the US. Worldwide maintains an office in California where it’s engineers are.

• Is worldwide engaged in a trade or business in the US following the acquisition?

• If worldwide is engaged in a trade or business what form would Worldwide have to file?

• Would the distribution of cash from the GetItRight branch in the US to Worldwide trigger a taxable event?


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Case Study #24

• Suppose that instead of acquiring the GetItRightbusiness, Worldwide hired four permanent employees in the US to manage its US stock market investments. The US employees receive monthly statements and dividend checks, make deposits and corresponds with brokers per the direction of the London home office. Would Worldwide be engaged in a US trade or business?


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Case Study #25▪ Power Clean, Inc. a Cayman Islands corporation purchases

vacuum cleaners in China and sells them around the world including the US. All sales are made with title and risk of loss passing outside the US. US orders for the vacuum cleaners are solicited by Power Clean’s traveling sales staff based in Hong Kong. Purchase orders are sent to the Cayman Islands office where they are accepted and filled from inventory warehoused in Hong Kong. Power Clean maintains no inventory, plant, office or other facilities in the United States.

• Is Power Clean subject to US tax on its profits from US sales?

• Would your answer to (a) change if US sales were made with title and risk of loss passing in the US?

• What if, on order to satisfy its customers’ demands for “just in time” inventory shipments, Power Clean leased warehouse space in St. Louis, Missouri, and filled all US sales orders from the warehouse?

• Would your answer to (c) change if Power Clean were a resident of a country that had an income tax treaty with the United States and Articles 5 and 7 of the treaty were identical to Articles 5 and 7 of the US Model treaty?


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Case Study #26

▪ Mei-Lin is a citizen and resident of Singapore. During 2017 she invested $50,000 in Reba Ventures, LLC, a Florida limited liability company organized to establish a new, annual women’s tennis tournament to be held in Sarasota, Florida. Reba has never elected to be taxed as a corporation. Mei Lin received K-1s from the company for 2018 and 2019 showing that her distributive shares of the company’s ordinary taxable losses for those years were $16,000 and $8,000 respectively. Since Mei-Lin has no other connections with the US, she decided she didn’t need to file a US tax return.

• Do you agree with Mei-Lin’s assessment?

• What is her potential exposure if she doesn’t file?


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FOREIGN INVESTMENT IN REAL PROPERTY TAX ACT (FIRPTA)


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FIRPTA – U.S. Real Property Interest §897

Under I.R.C., 897 gain or loss from the sale of a real property interest by a nonresident alien individual or a foreign corporation is treated as a result of an effectively connected business in the U.S.


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FIRPTA – U.S. Real Property Interest §897

U.S. real property interest is:

• Land

• Building (including personal residence)

• Mines, wells, and other natural deposits

• Interest in a domestic corporation that is a U.S. real property holding company (USRPHC)


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FIRPTA – §871(d)

▪ Election to treat investment in US real property as ECI – important planning step


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FIRPTA Withholding under §1445

▪ Buyer is required to withhold 15% of proceeds when purchasing US real property interest from foreign person


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FIRPTA Withholding under §1445

▪ Buyer is required to withhold 15% of proceeds when purchasing US real property interest from foreign person

▪ Form 8288 – FIRPTA Withholding Form


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Case Study #27

▪ Hilda is a citizen and resident of Country X and not a resident of the US. She owns a home in California. What are the consequences under FIRPTA if Hilda sells the home for $750,000?


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Case Study #28

▪ Jennifer is a citizen and resident of Singapore and not a resident of the US. She owns all of the stock of CostLess, a domestic corporation. CostLess’s assets consist of a factory with a fair market value of $500,000 machinery and equipment of $390,000 and an investment in a wholly owned US sub with a fair market value of $200,000. What are the US tax consequences to

▪ Jennifer if she sells her stock in CostLess?


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TAX FORMS FOR NON-RESIDENTS


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Non-Resident Individual

▪ Form 1040-NR – Non-Resident Individual Income Tax Return

▪ Form 8840 – Closer connection filing


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Non-Resident Corp

▪ Form 1120-F – Corporate income tax return for foreign corporation

▪ Form 8883- Treaty Based Return filing


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Domestic Corp with Greater than 25% Foreign Shareholder

▪ Form 5472 – Information return for domestic corp with 25% foreign shareholder

▪ 2017 – filing requirement expanded to included SMLLC owned by foreign person

• This filing requirement includes capital contributions and distributions

▪ $25,000 penalty for failure to file

▪ May have multiple filing requirements if have transactions with multiple related parties


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FOREIGN TAX CREDITS


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Purpose of the Foreign Tax Credit

▪ U.S. persons are subject to U.S. income tax on their worldwide income (i.e., U.S. source income as well as foreign-source income).

▪ Worldwide taxation without a foreign tax credit creates double taxation

▪ The foreign tax credit provisions are intended to provide relief from double taxation


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Purpose of the Foreign Tax Credit

▪ Subject to a number of limitations, U.S. persons may be eligible for a credit with respect to income taxes imposed by foreign jurisdictions on their foreign-source income.


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Credit Versus Deducting

▪ The foreign tax credit is elective. Taxpayers who do not elect to credit foreign taxes may deduct the taxes instead

▪ The FTC represents a dollar-for-dollar reduction of U.S. tax liability and, thus, is generally more favorable.

▪ The election to credit rather than deduct creditable foreign taxes is an annual election. (Forms 1118 and 1116)


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What is a Creditable Tax?

1) it is a tax and ▪ it requires a compulsory payment ▪ a penalty, fine, interest or similar obligation is not a tax, neither is

a customs duty a tax ▪ must exhaust all effective and practical remedies, including the

invocation of competent authority ▪ must be paid to a foreign government without receipt or

consideration of a direct or indirect specific economic benefit; ▪ Whether a foreign levy is an income tax is determined

independently for each separate levy 2.the predominant character of the tax is an income tax in the US sense


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Overall Foreign Tax Credit Limitation - §904

The FTC is used to avoid “double taxation of income”

▪ •The FTC limitation is designed to ensure that foreign taxes may be credited only against U.S. taxes that are imposed on the same foreign income.

▪ •The § 904(a) overall FTC limitation is calculated using the following formula:

This is applied on a separate basket basis.


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The FTC is used to avoid “double taxation of income”

▪ •The FTC limitation is designed to ensure that foreign taxes may be credited only against U.S. taxes that are imposed on the same foreign income.

▪ •The § 904(a) overall FTC limitation is calculated using the following formula:

This is applied on a separate basket basis.


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▪ Example 1: ▪ •U.S. taxpayer has $500 of taxable income for its 2019

taxable year ($250 derived from U.S. activities and $250 derived from service activities performed in France).

▪ -France levies taxes totaling $97. ▪ -The U.S. tax liability prior to the foreign tax credit is $175

(35% rate).

▪ The taxpayer’s FTC is limited to $87, leaving the taxpayer with $10 of unused FTC. The taxpayer’s U.S. tax liability is $88 following the application of § 904 ($175 - $87).


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▪ When looking at Foreign source income in this formula the foreign source income should be net of allocable expenses – this is not a gross number.

▪ Special allocations for interest expense, R&D and some others


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Case Study #29

▪ Taxpayer has $500 of taxable income for 2019 $220 is earned from U.S. sources and $250 from services performed in France. France levies a tax of $97. Total US tax is $175 (35% rate). What is taxpayer’s Foreign Tax Credit limitation?


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Case Study #30▪ John Smith is a U.S. citizen living in New Jersey.

During the day he works as an IT executive and moonlights as a software developer. He developed and patented a software SuperXwhichhe has been promoting in his free time. During 2019 he successfully promoted SuperX to a Japanese software company and received $10,000 royalty income for licensing the software for use in Japan, this income was subject to a $2,000 withholding tax in Japan. He incurred $1,000 out of pocket expenses directly related to the contract with the Japanese company. He earns $190,000 at his day job in New Jersey, has $30,000 of itemized deductions and his U.S. tax liability before any foreign tax credit is $40,000.

▪ What is John’s Foreign Tax Credit.


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QUESTIONS???


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Additional Case Studies

▪ Sven Svenson a Swedish national extended a loan to your client ABC Inc. The U.S. statutory withholding rate is 30%,the withholding rate under the treaty is 0%. What form does ABC Inc. need to obtain in order to apply the treaty rate? What happens if ABC does not receive that form?

▪ Same facts as in the previous question except the loan was extended to ABC Inc. by Svenson’s AB a Swedish corporation. What form does ABC Inc. need to obtain in order to apply the treaty rate? What happens if ABC does no receive that form?

▪ Svenson’s AB is a Swedish Operating company in the same line of business, manufacturing and selling widgets, as ABC Inc. complete the form that you identified in question 7 on behalf of Svenson’s AB.

▪ ABC Inc. received the form from Svenson’s do they have any responsibilities what should they do with this form?

▪ Annie (U.S. citizen) bought her condo in NYC from Jacques (a French citizen who is not a U.S. tax resident). What must Annie do to ensure compliance with withholding rules?


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▪ Tom is a Single U.S. Citizen, he has no dependents.▪ During 2017 Tom was living in the U.S. until April 30, 2017▪ He took an extended leave inGermany on May 1, 2017 for the remainder of the

year.▪ During his time in the U.S. he had Gross Wages of $100,000, Federal Taxes

withheld of $25,000; Interest of $10,000, and Ordinary Dividends of $10,000▪ During his leave, Tom put some money in a German bank to earn interest for

some of his expenses while he was there. ▪ For 2017, the Foreign Interest from the Germanbank totaled $5,000 of which

he paid $1,000 of Tax in Germany. ▪ What Individual tax form should Tom prepare for 2017

▪ Tom is in the 28% Tax bracket, His AGI is $125,000▪ His Taxable income is $115,000 and his tax is $25,493 ▪ What is Tom’s FTC?


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▪ Sergey and Anthony two Italian brothers each own 50% of US Production Co and Italian InvestCo. During 2016 Italian InvestCo. formed US Real Estate LLC for which it was a 100% member. US Real Estate LLC bought a US manufacturing facility that it will lease to US Production Co in triple net lease. What should you communicate to Sergey and Anthony with respect to their investment in US Real Estate LLC.


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▪ FCo, a foreign corporation, has an agreement with USCo, an unrelated US corporation whereby USCo acts as FCo’s exclusive agent in selling FCo’s product in the US, and receives commissions for each sale made. FCo’s agreement with USCo states that all US sales must be approved by an employee in FCo’s home office in Switzerland. In the past four years, the home office has never rejected a US sale submitted for approval by USCo. The parties’ agreement also forbids USCo from acting as agent or principal in making sales of competing goods.• Is FCo engaged in a trade or business in the US?• Does FCo have a permanent establishment in the US under the terms of

the US model Income tax convention?• Would your answers to (a) and/or (b) change if FCo owned all of the stock

of USCo?• Would your answers to (a) and/or (b) change if USCo, instead of selling on a

commission basis, purchased the products from FCo and then resold them to customers in the US?


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▪ Gamerco, a US corporation, develops and markets computer gaming software. All of its engineers are located in the US. Once the software is ready for sale, the final version (the “golden master”) is sent to a disc duplicator in Texas to make 10,000 copies. The CDs are then boxed with the manual, shrink-wrapped, and sold to foreign customers with the license rights transferring to the customer when it breaks the shrink-wrap and thereby agrees to the license terms. Under the license terms the customer has the right to use the software on not more than two physical computers, and may not copy, distribute, publicly display, reverse engineer, or otherwise modify the software. Determine the source of Gamerco’s income under the following alternatives:• The software is transferred to the customer under a perpetual license• The software if transferred to the customer under a license with a term of 1 year. After 1

year, the customer may renew the license by paying another year’s fee. If a customer chooses not to renew, a license key built into the software will cause it to stop working at the end of the 1-year term.

• Would your answers to (a)or (b) change if the software were downloaded instead of being transferred on a physical CD?

• Would your answers to (a) or (b) change if the software were made available to users on a cloud based platform and never actually downloaded to the end users’ hard drive?


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▪ Matthias Hammerlein, a Swiss citizen and resident, has retained your professional tax advisory services. Matthias is considering making a significant investment in U.S stocks. He asks you the following two questions:• If the stocks appreciate and he later sells them at a

profit, will he be subject to U.S. tax on that profit?• If some of his investment is in large-cap, dividend

paying stocks, will he be subject to U.S. tax on the dividends he receives?

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