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Inbound Transactions and Federal Tax:

Compliance Issues With 1120-F, 8833 and Other Forms Tackling Protective 1120-Fs, Calculation of ECI and FDAP, Exemptions and Other Challenges

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WEDNESDAY, DECEMBER 5, 2012

Presenting a live 110-minute teleconference with interactive Q&A

James Sams, Principal, KPMG, McLean, Va.

Juan Carlos Ferrucho, Managing Director, Alvarez & Marsal Taxand, Coral Gables, Fla.

Kimberlee Phelan, Tax Services Partner, WithumSmith+Brown, Princeton, N.J.

Carola Knoll, International Tax Manager, WithumSmith+Brown, Princeton, N.J.

Silvia Flores, Senior Director, Alvarez & Marsal Taxand, Coral Gables, Fla.

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Inbound Transactions and Federal Tax: Compliance Issues With 1120-F, 8833 and Other Forms Seminar

Silvia Flores, Alvarez & Marsal Taxand

[email protected]

Kimberlee Phelan, WithumSmith+Brown

[email protected]

Dec. 5, 2012

Juan Carlos Ferrucho, Alvarez & Marsal Taxand

[email protected]

James Sams, KPMG

[email protected]

Carola Knoll, WithumSmith+Brown

[email protected]

Today’s Program

Overview Of Key Concepts

[Silvia Flores]

Fact Patterns With Implications For Inbound Investment Forms

[Juan Carlos Ferrucho and James Sams]

Application Of Concepts When U.S. Form Must Be Prepared

[Kimberlee Phelan and Carola Knoll]

Slide 8 – Slide 41



Notice

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY

THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY

OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT

MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR

RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

You (and your employees, representatives, or agents) may disclose to any and all persons,

without limitation, the tax treatment or tax structure, or both, of any transaction

described in the associated materials we provide to you, including, but not limited to,

any tax opinions, memoranda, or other tax analyses contained in those materials.

The information contained herein is of a general nature and based on authorities that are

subject to change. Applicability of the information to specific situations should be

determined through consultation with your tax adviser.

OVERVIEW OF KEY CONCEPTS

Silvia Flores, Alvarez & Marsal Taxand

U.S. TRADE OR BUSINESS ISSUES

U.S. Trade Or Business Issues

US Branch

Business Profits

Foreign

Corporation

Interest, Dividends,

Capital Gains

US Subsidiary

Interest & Dividends

Royalties

Rents

10

U.S. Trade Or Business: Defined

• When a foreign person’s activities within the U.S. are

considerable, continuous and regular:

― There is no statutory definition; rather, it depends on the

facts and circumstances.

― Regular and active solicitation in the U.S. was sufficient to

consider a taxpayer engaged in a U.S. trade or business.

• Effects of agents:

― Activities of an independent agent (e.g., U.S. distributor)

generally are not attributed to the foreign principal.

― Activities of a dependent agent (e.g., employee) are

attributed to the foreign principal.

11

U.S. Trade Or Business: Defined (Cont.)

• Partnership engaged in a U.S. trade or business:

― Each partner (including a foreign person) is considered to

be engaged in a U.S. trade or business

• U.S. subsidiary corporation:

― Activities are generally not attributed to a foreign parent

corporation.

12

U.S. Trade Or Business (Cont.)

Taxed on Effectively Connected Income

Net Basis

Secs. 1 or 11 rates

Yes

Taxed on US Source FDAP Income

Subject to exceptions

US Source non-FDAP income not

subject to US income tax

No

Foreign Person Engaged

in US Trade or Business

13

U.S. Taxation Of Foreign Persons Engaged In A USTB

• Territorial approach to business taxation of foreign persons

― The U.S. generally taxes only U.S. source income and certain foreign-

source income (i.e. involving U.S. office or its assets).

― It must be established that there is a U.S. trade or business before

foreign persons are subject to tax in the U.S. on business income.

• U.S. branch vs. U.S. subsidiary

― A U.S. branch subjects foreign parent to taxation and reporting in

the U.S. (e.g., Form 1120-F), plus additional provisions (e.g., branch

profits tax).

― A U.S. subsidiary is subject to normal U.S. corporate income taxation

with increased reporting requirements (e.g., Form 5472).

14

U.S. Trade Or Business Exceptions

• Performance of personal services are treated as a “trade or

business,” unless the de minimis exception applies (90

days/$3,000).

• Trade or business does not include certain trading in stock,

securities or commodities.

• Consider income tax treaties

15

SOURCE OF INCOME RULES

Source Of Income Rules

• In general:

― Interest income is sourced pursuant to the residence of

the obligor.

― Dividend income is sourced according to the residence of

the payor.

― Services income is sourced where the services are

performed.

― Rents from lessees of tangible personal/real property are

sourced where the property is located.

― Royalties from licensees of intangible personal property

are sourced where the intangibles are used.

17

Source Of Income Rules: Example

• Example:

A foreign corporation provides architectural services in the

U.S. for a construction project. Under U.S. law, the income

from the services is sourced where the services are

performed, in this case to the U.Ss.

18

Sale Of Inventory Property

• Sale of inventory property

― Sale of purchased inventory is sourced in the country

where the sale takes place. The sale is deemed to take

place where title passes.

― When the seller produces the property, the income must

be apportioned between the country of production and

the country of sale (referred to as “Sect. 863(b) income”).

Seller must source the gross income under a 50/50

allocation method, unless another method is elected.

Other methods are independent factory price and separate

books and records.

19

Sale Of Personal Property

• Sale of personal property other than inventory

― Sourced at the residence of the seller

― Gain on the sale of depreciable personal property is sourced

according to the prior depreciation deduction, to the extent of

the deductions. An excess is sourced the same as the sale of

inventory (country where the sale takes place).

― Gain on the sale of intangibles is sourced according to prior

amortization deductions ,to the extent of deductions.

Contingent payments are sourced as royalty income (country

where the intangibles are used).

― Generally, gain attributable to an office or fixed place of

business maintained outside the U.S., by a U.S. resident, is

foreign-source income.

― Sourcing of losses depends on the nature of the property

20

FDAP INCOME

FDAP

• Fixed or determinable annual or periodical income derived from

sources within the U.S. by foreign persons

• FDAP income can be a lump-sum payment or a series of payments.

• Generally includes:

• Interest

• Dividends

• Rents

• Royalties

• Premiums

• Annuities

22

FDAP (Cont.)

• Tax rate is 30% (or lower treaty rate) collected via

withholding. Tax is imposed on a gross basis (i.e. no

deductions allowed).

• Major exceptions from tax withholding:

• ECI FDAP income

• Portfolio interest

• Interest from bank deposits

23

EFFECTIVELY CONNECTED INCOME (INCLUDING FIRPTA)

Effectively Connected Income

• Income effectively connected with a U.S. trade or business includes

the following:

― U.S.-source business income, such as income from inventory

sales and performing services

― Certain types of U.S.-source FDAP income such as interest on

working capital, dividends earned by a dealer in securities, and

royalties from an active licensing business

― Force of attraction rule

― Certain foreign source income for which a U.S. office exists, and

such income is attributable to the U.S. office

― Deductions are allowable in arriving at ECI.

25

Effectively Connected Income (Cont.)

• In order for deductions to be allowed in arriving at ECI, the

taxpayer must timely file (within 18 months of the original

due date) a U.S. income tax return. If a return is not filed, the

IRS takes the position that it can tax the taxpayer on its gross

ECI income and thus disallow any deductions.

26

Withholding Tax Required By § 1446 On ECI

• If a U.S. partnership has ECI allocated to a foreign partner, the partnership is required to withhold at the highest applicable rate.

― Taxes withheld are treated as estimated tax payments.

― Taxes withheld are treated as partnership distributions.

• The following forms must be filed to report the withholding amounts by a partnership:

― Form 8804 (annual return for partnership withholding tax), Sect. 1446

― Form 8805 (foreign partner’s information statement of Section 1446 withholding tax)

― Form 8813 (partnership withholding tax payment voucher)

― A foreign partner that submits a Form W-8BEN for

1441 withholding tax purposes typically satisfies the documentation requirements under

1446.

27

U.S.-Source FDAP Income

• U.S.-source FDAP (fixed, determinable, annual or periodic) income is

treated as ECI if it meets either of the following two tests:

― Asset use test: FDAP income is derived from assets used or held

for use in a U.S. trade or business.

― Business activities test: Activities of a U.S. trade or business are

a material factor in generating the FDAP income.

• Capital gain income can also be ECI under the same principles.

If FDAP income is ECI, it is not subject to the

1441

withholding regime

28

FIRPTA: General Principles

• Foreign persons are generally not subject to U.S. income tax on

capital gains (exceptions include ECI capital gains). However, FIRPTA

treats the gain on a disposition of an interest in U.S. real property as

effectively connected income subject to regular federal income tax.

• FIRPTA requires buyers of U.S. real property interests to withhold 10%

of the sales price. The seller may apply to the IRS to reduce this 10%

to the amount of tax estimated to be due.

• FIRPTA applies in virtually all cases in which a foreign owner of a U.S.

real property interest disposes of that interest. Provisions of the law

which would prevent recognition of gain generally do not apply,

unless the seller receives a U.S. real property interest in a qualifying

non-recognition exchange.

29

U.S. Real Property Interest

• Real property located in the U.S. includes the following:

― Direct (land, buildings, natural resources, options, etc.)

― Indirect (partnership, estates, trusts)

― Certain associated personal property

― Any interest (other than solely as a creditor) in a domestic

corporation unless the taxpayer establishes that such corporation

was not a U.S. real property holding corporation at any time

within the past five years. It should be emphasized that the

corporation is treated as a USRPI, unless the taxpayer can

demonstrate otherwise

―Includes foreign corporation that has elected to be treated as a

domestic corporation for FIRPTA purposes [

897(i) election]

30

BRANCH PROFIT TAX

Branch Level Taxes: Policy Objective

Equalize treatment of U.S. branches and subsidiaries

Foreign

Parent

Corporation

$ payment

(intra-company

transfer)

U.S.

Branch

Foreign

Parent

Corporation

$ payment

(interest or

dividend)

U.S.

Subsidiary

32

Branch Profits Tax

• Branch profits tax is a branch-level tax of 30% on the repatriation of earnings, in the form of dividends, from a foreign corporation’s branch in the U.S. to the home office in a foreign country.

• This tax is also applied to excess interest on U.S. ECI at a rate of 30%.

• Only imposed on foreign corporations that have a U.S. trade or business

• The foreign corporation does not need a physical presence in the U.S. for the tax to apply.

• The amount of branch profits tax under a treaty is determined by either the branch profits tax amount or the dividend rate specified in the treaty.

33

U.S. Net Equity

• U.S. net equity = U.S. assets less U.S. liabilities

• U.S. assets are:

― Assets of the foreign corporation that produce U.S.

effectively connected income

― Adjusted basis used for E&P purposes

• U.S. liabilities are:

― Liabilities of the foreign corporation treated as connected

with the conduct of a trade or business in the U.S.

― Special rules in the regulations for calculating U.S.

liabilities

34

Computing Branch Profits Tax Current Year US Effectively Connected E&P

+ Decrease in US Net Equity*

or

- Increase in US Net Equity

Dividend Equivalent Amount (DEA)

x 30% rate (or lower treaty rate)

Branch Profits Tax

*Decrease add-back limited to accumulated effectively connected E&P as of the close of the prior year [§884(b)(2)(B)]

35

EFFECTS OF TAX TREATIES

Treaty Benefits

• Residency

• Limitation on benefits clause

• Sect. 894 determines which treaty is applicable in cases for

which treaty shopping may be an issue, and requires a

determination of which entity is the beneficial owner of the

income for foreign tax purposes.

• Form 8833

37

Permanent Establishment

• Higher threshold than the generic “trade or business” test

• Requires a fixed place of business, to include:

― Place of management

― Branch

― Office

― Factory

― Workshop

38

Permanent Establishment (Cont.)

• Permanent establishment excludes:

― Facility for maintenance of goods solely for storage,

display or delivery

― Maintenance of a fixed place of business solely for

carrying on activities that are preparatory or auxiliary in

nature

― Engagement of broker or agent of independent status

― Certain temporary projects

― Subsidiary of parent, unless parent carries on business

itself

39

• An enterprise shall not be deemed to have PE as a result of carrying

on a business through a broker or other independent agent who is

acting in the ordinary course of their business.

• A dependent agent who exercises authority to conclude contracts in

the name of the enterprise, will normally create a PE for the

enterprise on whose behalf the agent is acting.

• Construction PE

• Services PE

Permanent Establishment (Cont.)

40

Business Profits Attributable To A PE

• Business profits are taxable only in the country of residence, unless

the enterprise carries on and the income is attributable to a

permanent establishment.

― Treaty taxes a PE as if a distinct and independent enterprise

engaged in the same or similar activities

― Note the difference from general “force of attraction” rule with

ECI

• In determining business profits, expenses are allowed as deductions

that are incurred for the purposes of the permanent establishment.

― That includes an appropriate allocation of head office expenses

― IRS takes the views that branch head office transactions are not

recognized, and that interest allocable to the U.S. PE is done

under U.S. tax principles.

41

FACT PATTERNS WITH IMPLICATIONS FOR INBOUND INVESTMENT FORMS

Juan Carlos Ferrucho, Alvarez & Marsal Taxand

James Sams, KPMG

INDUSTRY OR ACTIVITY FACT PATTERNS

Communications, Space And Ocean

44

Communications Activities

• Sect. 863(e) defines international

communications income as all income

derived from the transmission of

communications or data from the U.S.

to any foreign country (or possession of

the U.S.), or from any foreign country

(or possession of the U.S.) to the U.S.

• U.S. person – 50/50 sourcing (no

exception in statute)

• Foreign person – except as provided in

regulations, foreign-source unless

attributable to a U.S. office or fixed

place of business maintained by the

foreign person

45

Communications Activities (Cont.)

• Final regulations (Treas. Reg.

1.863-9) effective 2007 add new categories of

income from “communications activities.”

• Define “communications activity” – delivery by transmission, provision of

capacity to transmit to transmit

• Provision of content or additional services with, or in connection with, a

non-de minimis communications activity must be separated.

• Determine type of “communications activity” – identify two points between

which the taxpayer is “paid to transmit” the communication

• International communications

• U.S. communications

• Foreign communications

• Space and ocean communications

• Burden is on the taxpayer to prove ending points through consistently applied

reasonable methods, or face a U.S.-source rule.

46

Communications Activities (Cont.)

• Source may be based on “functions performed, resources

employed, or risks assumed.”

• ICI – foreign person general rule

• ICI – CFC 50/50

• ICI – foreign person maintaining US office or fixed place of

business (see

864(c)(5))

• ICI – foreign person with U.S. trade or business (treaty?)

• Source of space and ocean communications income – see space

and ocean regulations Treas. Reg.

1.863-8

• Determine taxable income from communications activities by

apportioning losses, expenses and other deductions

47

Space And Ocean Activities

• Sect. 863 defines space and ocean

activity as any activity conducted in

space and any activity conducted on or

under water, not within the jurisdiction

(as recognized by the U.S.) of a foreign

country, possession of the U.S., or the

U.S.

• Generally, any space and ocean income

derived by a U.S. person is sourced in

the U.S., and any space and ocean

income derived by a foreign person is

foreign -source.

• Exceptions for transportation,

international communications and

mining, oil, etc.

48

• Except as provided in the regulations, space and ocean income

derived by a U.S. person is U.S.-source income, and income

derived by a foreign person is foreign-source income.

• Regulations provide that source (“source rule”) may be based

on “functions performed, resources employed, or risks

assumed”

• Foreign-source for U.S. person or CFC with functions, risks

or resources in a foreign country

• U.S.-source for foreign person with U.S. trade or business

and functions, risks or resources in the U.S.

• Special sourcing rules for income from services,

communications activities and certain sales of property

Space And Ocean Activities (Cont.)

49

• Service is considered entirely space and

ocean activity when any part of the service

is performed in space or international

waters. De minimis exception applies when

the value of space and ocean services is

immaterial.

• Functions are performed, resources are

employed, or risks are assumed in space or

international waters; regardless of whether

performed by personnel, equipment or

otherwise (“character rule” as

distinguished from “source rule”)

• Taxpayer may treat only a portion of

service as space and ocean, if it can show

the allocation of the value between space

and ocean and outside space and ocean.


50

• Activities performed by another person are generally not attributed to the

taxpayer, for purposes of determining the taxpayer’s income from space and

ocean activities.

• Content provider vs. satellite capacity delivery

• Treasury Reg. 1.863-8 provides specific rules for income from property

produced by the taxpayer, in whole or in part, in space or on or underwater

not within the jurisdiction of a foreign country, possession or the U.S., or

from the sale of property in space or international water. (See Treas. Reg. 1.863-3).

• Purchased property sold in space or international water follows the same

sourcing rules as income from space and ocean activities, unless it is

inventory property.

• Purchase inventory property follows the “title passage” rule if it is sold

for use, consumption or disposition outside of space or international

water, and there is no motive to avoid tax.


51

• If a taxpayer produces and sells property, then allocate income using a 50/50

method.

• If the production income and/or the sales income is from space and ocean

activities, then the sourcing for that portion of the income will be under the

regulations for space and ocean income.

• If production occurs both in and outside space and international waters, then

one should apportion production income using a functions performed,

resources employed or risks assumed analysis. Sourcing of the space and

international waters portion is done under the general sourcing rules for

space and ocean income.

• If the sales activity is entirely outside space and international waters, then

the sales income is sourced outside the space and ocean income rules (i.e.

title passage, etc.). If the sales is within space and international waters,

then use the general rules for sourcing the income (except if inventory

property is for use, consumption and disposition outside space and

international waters, and the U.S., then use “title passage, etc.”).


52

Electronic Commerce

53

Electronic Commerce (Cont.)

• Traditionally, the concept of PE required some physical presence in

the country seeking to impose tax.

• However, it is no longer necessary for companies to have a physical

place of business in a country in order to sell products or services in

that country.

• Many companies use the Internet as their sole sales mechanism.

• There is a lack of consensus among the worldwide taxing authorities

as to what constitutes a PE in the context of e-commerce.

• Countries are taking inconsistent positions on whether the location of

a Web site on a server in a country can constitute a PE, increasing

the risk of double-taxation.

54

Electronic Commerce (Cont.)

• To date, there is no direct U.S. authority guidance discussion whether a person’s

activities constitute a PE in situations involving e-commerce.

• OECD’s views on the taxation of e-commerce has not been released yet; however,

the following insights have been provided:

• Web sites should not constitute PEs.

• Web site hosting facilities should not produce PEs for the entity carrying on

business through the site.

• Internet service providers should not represent an agency position and give

rise to a PE.

• Servers located in a jurisdiction for a suitable long period may be considered

fixed and constitute a PE.

• The OECD’s stance seems to be that a server may only constitute a PE when the

automatic functions carried out by the equipment have been set up by the

principal enterprise and continue to be operated, controlled and maintained by

the same principal enterprise.

55

Distribution Ad Sales Activities

56

• Attribution of U.S. trade or business through agents

• Exclusive or dependent agents may create a trade or business for

foreign principal depending on the activities involved.

• Independent agents generally should not create a trade or

business.

• U.S. activity related to sales and marketing

• Facts and circumstances

• Repeated vs. isolated sales

• Extent of solicitation, marketing, negotiation and other

relationship activities

• Maintenance of inventory, displays, warehouse, logistics and

other related support activities

Distribution And Sales Activities (Cont.)

57

U.S. Marketing And Sales Function (Example)

• Spanish resident company sells products to U.S. resident customers.

• Inventory purchased or produced in Spain. Final decision-making about sales is in Spain.

• Company will hire a U.S. sales agent working from home, but there is no office or office space for the company.

• Employee will promote products, attend trade shows, engage in marketing campaign, gather market data, identify target clients and solicit sales.

• All customer orders will go directly to Spain for review, credit terms and final approval. Spain will also handle warranty and follow-up customer relationship management.

58

U.S. Marketing And Sales Function (Example), Cont.

• Example (Cont.):

• Unlikely to be a permanent establishment under the U.S.-Spanish Treaty, assuming Spanish company meets the limitation on benefits clause

• Spanish company will need to comply with:

• U.S. tax identification requirements(federal and state)

• U.S. bank account for expenses and payroll

• U.S. payroll obligations

• U.S. sales and use tax issues

• State and local income tax issues (assuming nexus is created) or capital or other type of non-income taxes

• File U.S. tax return with treaty based return position

59

Stewardship

• A foreign holding company generally

should not be considered to be

engaged in a U.S. trade or business

solely as a result of its directors,

officers, or employees:

― Exercising management

oversight and stewardship of

the company's investment in a

U.S. operating subsidiary, or

― Investigating business

opportunities in the U.S. such

as potential acquisitions or

sales of subsidiaries.

60

© 2012 KPMG LLP, a Delaware limited liability partnership and the US member firm of the KPMG network of independent

member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

NDPPS 134002

61

**********

ANY TAX ADVICE IN THIS REPORT IS NOT INTENDED OR WRITTEN BY KPMG TO BE USED, AND CANNOT BE

USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT

MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER

PARTY ANY MATTERS ADDRESSED HEREIN.

Any tax advice in this document is limited to the conclusions specifically set forth herein and is based on the

completeness and accuracy of the stated facts, assumptions and representations. If any of the facts, assumptions or

representations herein is not entirely complete or accurate, it is imperative that we be informed immediately, as the

inaccuracy or incompleteness could have a material effect on our conclusions. In rendering our advice, we are relying

upon the relevant provisions of the Internal Revenue Code of 1986, as amended, state and local tax statutes, the

regulations thereunder, and the judicial and administrative interpretations thereof. These authorities are subject to

change, retroactively and/or prospectively and any such changes could affect the validity of our advice. We will not update

our advice for subsequent changes or modifications to the law and regulations, or to the judicial and administrative

interpretations thereof.



NDPPS 134002

62

Agenda For Next Part Of Presentation

• IRC

875(a)(1) – U.S. trade or business of foreign partners through a

partnership

Application of

875(a)(1) to foreign limited partners

Permanent establishment of foreign partners through a partnership

• Disposition of interest in a partnership with a U.S. trade or business

by a foreign partner

• Revenue Ruling 91-32

• Activities of investment funds

• GLAM 2009-10

• U.S. trade or business created through agency - InverWorld



NDPPS 134002

63

The statute: “A nonresident alien individual or foreign corporation shall be considered as being engaged in a trade or business within the United States if the partnership of which such individual or corporation is a member is so engaged.”

Foreign

Corporation

Foreign

Individual

USTB

Partnership

Sect. 875(1) – Creation Of A U.S. Trade Or Business

Through A Partnership Interest



NDPPS 134002

64

Foreign

Corporation

(LP)

Foreign

Individual

(LP)

USTB

Partnership

Unger v. CIR: A non-resident alien individual limited partner was treated as having a permanent establishment by reason of the partnership’s U.S. permanent establishment in the U.S. Thus, the individual was taxed on his distributive share of the partnership’s long-term capital gain from the sale of real estate situated in the U.S.

Donroy v. CIR: Foreign corporate limited partners in a U.S. limited partnership were treated as having a permanent establishment in the U.S. by reason of the limited partnership’s permanent establishment in the U.S.

General

Partner

Attribution Of A U.S. Permanent Establishment

To Limited Partners



NDPPS 134002

65

Foreign

Corporation

(Seller)

USTB

Partnership

Rev. Rul. 91-32: If a foreign partner sells an interest in a partnership that carries on a U.S. trade or business (or is a permanent establishment under a treaty), Rev. Rul. 91-32 provides rules for determining the portion of the gain or loss that is effectively connected to the U.S. trade or business (or attributable to the permanent establishment).

For this purpose, the foreign partner is treated as if the partnership sold its assets, and the foreign partner received its distributive share of the resulting gain or loss.

Purchaser of

Partnership

Interest

Disposition Of Interest In A Partnership That Has A

U.S. Trade Or Business By A Foreign Partner



NDPPS 134002

66

Disposition Of Interest In A Partnership:

Application Of Rev. Rul. 91-32

In applying Rev Rul. 91-32 there are five basic principles

1. Cannot net gains and losses from the effectively connected and non-

effectively connected pools

2. If loss on actual disposition, but net effectively connected gain on hypo

disposition, then the actual loss is a non-effectively connected loss. If gain on

actual disposition, but net effectively connected loss on hypo disposition, then

the actual gain is non-effectively connected gain

3. There is a rebuttable presumption that gain is effectively connected to a U.S.

trade or business, and that a loss is not effectively connected.

4. U.S. real property of the partnership is not considered within the Rev. Rul. 91-

32 calculation. Instead, the foreign partner will apply the rules of Sect. 897(g),

which apply the Sect. 897 tax regime to the portion of the partnership interest

related to the U.S. real property.

5. Any property contributed by the foreign partner in anticipation of the

disposition of its partnership interest with the purpose to gaining a U.S. tax

benefit may be disregarded by the IRS.



NDPPS 134002

67

Disposition Of Interest In A Partnership:

Application Of Rev. Rul. 91-32 (Cont.)

The Greenbook, documenting President Obama’s tax reform proposals,

includes the codification of Rev. Rul. 91-32.

Stated reason for codification: Non-resident alien individuals and foreign corporations

may take a position contrary to the holding of Rev. Rul. 91-32, because it is not

explicitly provided for in the Code. The issue of non-taxation is amplified if the

partnership has in effect an election under IRC

754, and can adjust the basis of its

assets upon the transfer of an interest in the partnership to reflect the transferee

partner’s basis in the partnership interest.

The proposal would also codify an enforcement mechanism. Enforcement of Rev. Rul.

91-32 would be accomplished by imposing a 10% withholding tax, to be withheld by

the transferee, on the foreign partner’s amount realized upon disposition. If the

transferee failed to withhold, the partnership itself would be liable for the amount of

under-withholding.

The estimated additional revenue for the government as a result of the codification of

Rev. Rul. 91-32 is $2.561 billion over the next 10 years.



NDPPS 134002

68

Foreign Lending

Corp.

(no U.S. treaty)

Origination Co.

domestic corp.

Loan agreement

U.S.

Borrowers

Arms-length

fee $$

U.S. loan-

originating

services

Solicitation and

negotiation of loans

Approve /

sign loans

Foreign Corps Lending In The US: GLAM 2009-10

Foreign lending corp. (FLC) will have a trade or business within the U.S. under the following

facts:

• FLC does not have an office or any employees situated within the U.S.

• FLC pays Origination Co. (OC), an unrelated U.S. corporation that has a U.S. office, to

negotiate and solicit loan contracts with U.S. lenders on FLC’s behalf.

• OC sends all loans back to FLC for final approval and execution of the loan agreements

between FLC and the U.S. borrower.



NDPPS 134002

69

Foreign Lending

Corp.

(no U.S. treaty)

Origination Co.

domestic corp.

Loan agreement

• Although OC cannot conclude contracts on FLC’s behalf, OC is still acting as FLC’s agent.

• The lending activities of FLC constitute a trade or business because they are regular and continuous, and they are situated within the U.S. because FLC is attributed OC’s U.S. activities.

• The interest earned by FLC on the U.S. loans is effectively connected to the U.S. business since it is attributable to the “US office” through which the business is carried on.

• This is a somewhat controversial position, since the U.S. office here is not attributable to FLC under the current regulations because of OC’s lack of signatory power.

U.S.

Borrowers

Arms-length

fee $$

U.S. loan-

originating

services

Solicitation and

negotiation of loans

Approve /

sign loans

Foreign Corps Lending In The

US: GLAM 2009-10 (Cont.)



NDPPS 134002

70

Foreign Corp

Issues Caused By Foreign Corporations

Directly Operating In The U.S.

U.S. Branch Or

U.S PE

Through

Employees

Key issues created by this structure

• Creates a direct U.S. tax filing/reporting requirement by Foreign Corp (Form 1120-F)

• Allocation of income/expenses to U.S. branch/PE’s activities can be a lengthy and complex process.

• Foreign Corp will be subject to the U.S. branch profits tax (BPT).

• The BPT rules impose a 30% withholding tax on a hypothetical “dividend equivalent amount” from the U.S. branch to the Foreign Corp.



NDPPS 134002

71

Foreign Corp

(FC)

Use Of A U.S. “Blocker” Subsidiary

To Avoid U.S. Tax Issues

FC’s

Employees

Operating In

U.S.

Creating an intervening “blocker” U.S. subsidiary,

by itself, will not prevent FC from having a USTB,

and being subject to the issues stated in the

previous slide.

Planning around USTB Issues

• Placement of FC employees who will be

working in the U.S. into the U.S. subsidiary

• Limit the direct U.S.-based activity of foreign

parent (e.g., U.S. marketing and sales by direct

employees or officers of foreign parent)

• Review/restructure U.S. customer relationships

so that they are contracting with the U.S.

subsidiary

Transfer pricing: By operating in the U.S. through a

separate regarded entity, FC will now face new

transfer pricing issues arising from inter-company

transactions.

“Blocker”

U.S. Corp



NDPPS 134002

72

InverWorld Ltd.

foreign corp

InverWorld

Holdings

domestic corp

InverWorld Inc.

domestic corp

Services

exclusively

provided to

related party

InverWorld v Commissioner

• InverWorld Ltd. (LTD) is a foreign

investment management and financial

services company. LTD’s target

customers were in Mexico.

• LTD collected management fees and

other commissions related to investment

opportunities within U.S. financial

markets from its Mexican clientele.

• InverWorld Inc. (INC) maintained LTD’s

client account files, provided investment

advice to LTD, performed bookkeeping

services for LTD, and purchased

investment instruments on behalf of

LTD’s customers, all from its U.S. office.

The Need For Substantial Foreign Activity:

InverWorld v. Commissioner



NDPPS 134002

73

InverWorld Ltd.

foreign Corp

InverWorld

Holdings

domestic Corp

InverWorld Inc.

domestic Corp

Services

exclusively

provided to

related party

Court ruling and lessons learned from

InverWorld v Commissioner

• The court looked at the aggregate of

LTD’s activities, both foreign and

domestic, to determine LTD’s “real

business.”

• Since a substantial volume of LTD’s

activities, directly and through INC (which

was determined to be acting as its

agent), were related to U.S. financial

markets, LTD was held to have a U.S.

trade or business.

• The court suggests that if LTD had more

activities related to foreign jurisdictions,

that its “real business” may not have

been within the U.S.

The Need For Substantial Foreign Activity:

InverWorld v. Commissioner (Cont.)

APPLICATION OF CONCEPTS WHEN U.S. FORM MUST BE PREPARED

Kimberlee Phelan, WithumSmith+Brown

Carola Knoll, WithumSmith+Brown

WithumSmith+Brown, PC ▪ Certified Public Accountants and Consultants

75 withum.com

Form 1120-F

Filing of U.S. income tax return of a foreign corporation

• Taxpayers engaged in conduct of U.S. trade or business (or that have U.S.-source taxable capital gains ) must file income tax returns.

• Taxpayers not engaged in a U.S. trade or business do not file if all tax is collected by the withholding agent.

• If no exemption applies, the withholding agent (typically, the payor) must withhold the 30% tax and file an information return.

• If a treaty exemption or reduction applies, withholding agent must have certification from payee:

Form W-8 BEN: “beneficial owner” of income and/or entitlement to treaty benefits

• Recipient must file “treaty-based return position disclosure” with IRS on Form 8833 to claim a treaty-based position.


76 withum.com

Form 1120-F (Cont.)

Filing of U.S. income tax return of a foreign corporation (Cont.)

• Foreign corporations that carry on business in the U.S. through a

“permanent establishment” (PE) are subject to U.S. tax on a

“net” basis.

Gross income attributable to the PE = effectively connected income

• “Permanent establishment” (PE): Standard definition

Fixed place of business

Dependent agent that has authority and does conclude

contracts


77 withum.com

Form 1120-F (Cont.)

U.S. income tax return of a foreign corporation (Cont.)

General rules

Tax base: Effectively connected income (§864(c))

U.S.-source business income

Selected types of foreign-source business income

Selected types of U.S.-source, non-business income

Lookback rules for property dispositions: 10 years, under §864(c)(7)

• Tax rate schedule: Same as domestic corporation

Basis of accounting

• U.S. tax forms are filled out in accordance with U.S. tax accounting principles.

• Taxpayers must convert U.S. GAAP financial records to U.S. tax basis of accounting, by making tax adjustments.


78 withum.com

Form 1120-F (Cont.)

U.S. income tax return of a foreign corporation (Cont.)

Interest expense

• A foreign corporation is generally required to use a three-step calculation to determine the amount of interest expense that is allocable under Sect. 882(c) to income effectively connected (or treated as effectively connected) with the foreign corporation’s conduct of a trade or business within the U.S.

• Fungibility principle

Allocate interest to all gross income, even if borrowing relates to specific asset

• Apportionment base

Two methods available: Fair market value or tax book value

864(e)(2)

• Affiliated groups

Treated as a single corporation, for purposes of apportioning interest expense


79 withum.com

Form 1120-F (Cont.)

Protective filing of U.S. income tax return on Form 1120-F

• Foreign corporations that do not file a return lose the right to take deductions and credits against “ECI.”

• Under Reg. Sect. 1.882-4(a)(3)(vi), the corporation will preserve its rights to deductions and credits by filing a protective return, if it is later determined that it did have “ECI.”

• Consider filing a “protective” return when:

The foreign corporation has only limited activity in the U.S., and there is no income “effectively connected with a trade or business in the U.S.”

The foreign corporation determines it has no U.S. tax liability under the provisions of an income tax treaty (e.g., when it does not have a permanent establishment in the U.S.).


80 withum.com

Form 1120-F (Cont.)

Protective filing of U.S. income tax return of Form 1120-F (Cont.)

• A “protective” Form 1120-F return:

Does not report income or deductions

Statement is attached stipulating that the return is being filed to “protect” the taxpayer’s right to claim deductions and

credits later, if it is determined it has ECI.

If the foreign corporation determines it has no U.S. tax liability

under the provisions of an income tax treaty (e.g., when it

does not have a permanent establishment in the U.S.), then

the Form 8833 must be attached.


81 withum.com

Form 8833

Treaty based return position disclosure under sections 6114 or 7701(B)

• Used to disclose treaty-based return position required by Sect.

6114

• Also used by dual-resident taxpayers to make the treaty-based

return position disclosure required by Sect. 301.7701(b)-7


82 withum.com

Form 8833 (Cont.

Treaty based return position

• Failure to disclose a treaty-based return position may result in a

penalty of $1,000 ($10,000 in the case of a C corporation)!

• Must disclose each treaty-based position on separate Form 8833

• IRC Sect. 6712


83 withum.com

Form 8833 (Cont.)

Income tax treaties

• Generally apply only to residents of a treaty country

• Often include reduced tax rates or exemptions from tax

• Check wording of each treaty! Each is written differently.

• U.S. treaties have a “savings clause.”

• Generally must disclose treaty positions (Form 8833)

• Watch out for states!


84 withum.com

Form 8833 (Cont.)

Income tax treaties – used To avoid double-taxation

Commonly used articles for businesses:

• Article 4 – residency (“treaty tie-breaker”)

• Article 5 – permanent establishment (PE)

• Article 7 – business profits

• Article 10 – dividends (5% if > 10%, 15% otherwise)

• Article 11 – interest (0% or 15%)

• Article 14 – independent services (self-employment)

• Article 15 – dependent services (employment/salary)

• Limitation-of-benefits article – must not have “LOB” apply or will not be eligible to claim treaty position


85 withum.com

Form 8833 (Cont.)

Treaty based return position

Limitation-of-benefits article - used to prevent “treaty shopping”

Ownership provisions deny benefits to a company that is a resident of

a contracting state, if it is owned or controlled directly or indirectly by

persons who are not residents of a contracting state.

General subject-to-tax provisions provide that treaty benefits in the

state of source are granted only if the income in question is subject to

tax in the state of residence.

For example, a foreign corporation may not be entitled to a reduced

rate of withholding, unless a minimum percentage of its owners are

citizens or residents of the U.S. (or the treaty country).

Some treaties provide that the benefits of the treaty apply if a

“derivative benefits” test is met. Other treaties provide that the

benefits of the treaty apply if a “headquarters company” test is met.


86 withum.com

Form 8833 (Cont.)

Treaty based return position (Cont.)

UK limitation-of-benefits Article 23: • Qualification of companies – generally:

Public companies (listed on U.S. or UK stock exchange) Ownership test

• On at least ½ days of taxable period, at least 50% owned (directly or indirectly) by “qualified” shareholders

Base erosion test • Less than 50% of gross income is paid to non-U.S. or UK residents • Payments are deductible in corporation’s jurisdiction

• Qualification of Income Derivative benefits test

• 95% or more of company is owned by seven or fewer “equivalent beneficiaries (member of EU or EEA, or a party to NAFTA)

• Must be resident in EU and “entitled” to benefits Active trade or business test Discretionary determination by competent authority


87 withum.com

Form 5472

Information return of a 25% foreign-owned U.S. corporation, or of a foreign corporation engaged in a U.S. trade or business

• Required to be filed when there has been a reportable

transaction during the year with a related party

• Due by extended due date of the U.S. income tax return and filed with that return

• Penalties for non-compliance begin at $10,000,


88 withum.com

Form 5472 (Cont.)

Reportable transactions

• Sales and purchases of stock in trade (inventory)

• Sales and purchases of tangible property other than stock-in-trade

• Payment or receipt of rents or royalties (other than amounts reported under (4) below)

• Sales and purchases of intangible property, as well as payment for use of intangible property such as copyrights, patents, processes, trademarks and other similar intangible property rights

• Payment or receipt of consideration for the rendition of technical, managerial, engineering, construction, scientific or other services

• Payment or receipt of commissions

• Loans or borrowing of money

• Payment or receipt of interest

• Payment or receipt of premiums for insurance and reinsurance


89 withum.com

Form 5472 (Cont.)

Information return of a 25% foreign-owned U.S. corporation, or of a foreign corporation engaged in a U.S. trade or business (Cont.)

• Not required to be filed if NO reportable transactions during the

year

• Not reportable if neither party to the transaction is a U.S. person under Sect. 7701(a)(30) and the transaction

Won't generate gross income from U.S. sources or deferred

payment or income that is ECI of a U.S. trade or business in any tax year, and

Won't generate in any tax year any expense, loss or other

deduction that is allocable or apportionable to the income

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