mastering the effectively connected income rules for...

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Mastering the Effectively Connected Income Rules

for Foreign Persons Engaged in Inbound Transactions

TUESDAY, SEPTEMBER 22, 2015 1:00-2:50 pm Eastern

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mailto:[email protected]

Sept. 22, 2015

Mastering the Effectively Connected Income Rules

Daniel R. Blickman

Blank Rome

[email protected]

Jeffrey M. Rosenfeld

Blank Rome

[email protected]

James K. Sams

KPMG

[email protected]




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.

Effectively Connected Income Rules for

Foreign Persons Engaged in Inbound

Transactions Presented By:

Jim Sams

Daniel Blickman

Jeffrey Rosenfeld

September 22, 2015

© 2014 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member fi rms affiliated with

KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Printed in the U.S.A.

FOR INTERNAL USE ONLY. Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.

JAMES K. SAMS, Principal

Professional and Industry Experience Jim provides high-level technical assistance and tax consulting services to clients on a wide-range

of complex inbound and outbound US international tax transactions and issues. Primary areas of

practice include US-inbound financing and debt restructuring, IP planning, CFC and foreign tax

credit planning, acquisition structuring/restructuring for multinationals, and acquisitions,

dispositions and structuring for private equity and real estate/infrastructure funds.

Jim joined KPMG LLP in December of 1993, in the Firm’s Washington National Tax practice in

Washington, DC, and has worked in the Firm’s San Francisco and London practices. He returned

to the Washington DC area in the summer of 2009.

Jim began his tax career as a law clerk for the Honorable B. John Williams, Jr. of the United

States Tax Court, following which he joined the Office of Associate Chief Counsel (International) in

the Office of Chief Counsel of the IRS in the fall of 1987. He also served as Special Counsel to the

Deputy Chief Counsel, as an advisor to the Deputy Chief Counsel and the Acting Chief Counsel

on regulations, rulings and other matters for their review.

Jim has published articles in Tax Management International Journal, International Tax Review,

and other journals, and has been a speaker at such organizations as the Tax Executives Institute,

ATLAS and Executive Enterprises, among others. He also has been an Adjunct Professor in the

graduate tax law program at the Georgetown University Law Center, and was a Senior Visiting

Fellow at the London School of Economics.

Representative Industries

Private Equity, Aircraft Leasing, Manufacturing and Retail, Pharmaceutical, Real Estate and Funds

Structuring

JAMES K. SAMS Principal

KPMG LLP

1676 International Drive

McLean, VA 22101

Tel 703-286-8492

Fax 703-991-6423

Cell 703-582-3554

[email protected]

Function and Specialization Jim is a principal in KPMG’s International Corporate Services practice in the Mid-Atlantic Area.

Education, Licenses & Certifications A.B. International Relations and Economics,

Brown University

Juris Doctor, University of Michigan Law School

Daniel Blickman has substantial experience in a wide range of federal and state tax

issues. He has represented large public companies, middle-market companies, small or

start-up companies, and individuals in all aspects of:

• mergers and acquisitions

• issuance of securities

• reorganizations, redemptions, and liquidations, both domestic and international

• using corporations, partnerships, and joint venture structures

He also has extensive experience in the formation of investment funds, real estate

transactions, compensation issues, cross-border investments (both in-bound and out-

bound), securitizations, and capital market issues, including swap agreements.

Daniel R. Blickman

Daniel R. Blickman

Partner

Blank Rome LLP

215.569.5373

[email protected]

Education:

New York University, LLM Tax

Yale Law School, JD


Jeffrey Rosenfeld concentrates his practice in the area of business tax law. Mr. Rosenfeld has significant experience counseling corporate clients and individuals in a broad array of tax matters including:

– domestic and international tax matters;

– state and local tax planning;

– tax-efficient structuring of domestic and international mergers, acquisitions, divestitures,

– reorganizations, spin-offs, redemptions and liquidations;

– formation, operation and acquisition of Subchapter S Corporations, partnerships and limited liability companies;

– federal, state, and local criminal and civil tax controversies, including audits, administrative appeals, and litigation; and,

– issuances of equity-based compensation.

Mr. Rosenfeld also counsels individual and corporate clients regarding undeclared foreign bank accounts, including “FBAR” reporting obligations, and has represented numerous clients in the Internal Revenue Service’s Offshore Voluntary Disclosure Program. Mr. Rosenfeld frequently writes on issues related to the FBAR and FATCA rules and regulations and international tax compliance issues.

Jeffrey Rosenfeld

Jeffrey M. Rosenfeld

Associate

Blank Rome LLP

215.569.5752

[email protected]

Education:

New York University, LLM Tax

University of Pennsylvania, JD


9

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AGENDA

• Introduction

• Definition of ECI

• Trade or business, partnerships, beneficiary of trust engaged in business

• ECI contrasted with FDAP

• Form 1120-F

• Withholding requirements and exemptions

• Case study illustration

10

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AGENDA

• Introduction




• Form 1120-F



11

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Overview

• U.S. Source FDAP income subject to 30% tax

• Collection via withholding by U.S. payer

• Key Exceptions

• Treaty Withholding Rates; and,

• Portfolio Interest Exception

12

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Overview

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

• Subject to full graduated rates (currently 35% for

corporations and 39.6% for individuals, trusts and

estates) on income that is effectively connected with

its U.S. trade or business (“ECI”)

• Deductions permitted

• U.S. tax returns need to be filed

• Branch Profits Tax

13

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Overview

• Analytical steps for foreign taxpayers

• If the taxpayer is not engaged in a U.S. trade or business, it is FDAP income

• If FDAP

• Is it U.S. source or foreign source?

• If U.S. source, is there an applicable treaty?

• If trade/business income

• Is there a U.S. trade or business?

• Is there an applicable treaty?

• Permanent establishment?

• Income attributable to PE?

• Apply ECI rules

14

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AGENDA

• Introduction




• Form 1120-F



15

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Trade/Business Investing (ECI)

Foreign Corp. Foreign Corp. Foreign Corp.

U.S. Branch

(U.S. T/B)

U.S. Partnership

(U.S. T/B or

U.S. Real Estate)

U.S. Real Estate

The technical term for income effectively connected with a

U.S. trade or business is ECI (effectively connected income).

16

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Contrast with FDAP Structure (30% Flat Tax)

Foreign Corp.

U.S. Corp.

Operating

income

U.S. corporate income tax –

Operational Tax

Foreign country corporate tax

– Repatriation Tax

Dividends or interest; U.S. Withholding Tax


Cash investment in stock or

debt Transaction Tax, if any

17

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What is ECI?

• “Income effectively connected with a U.S. trade or

business”

• Two Threshold Concepts

• U.S. Trade or Business, and

• Effectively Connected Income

18

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U.S. Trade or Business

• What is a U.S. trade or business?

• No definition

• Service not likely to issue private rulings on the matter

• Activity must be substantial, continuous, and regular

• Isolated transactions can be a U.S. trade or business

19

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U.S. Trade or Business (cont’d)


• Ministerial, clerical, or collection-related activities, usually not

sufficiently profit-oriented to constitute a U.S. trade or business.

• Scottish American Investment Co. v. Commissioner - Foreign

trust has U.S. office to collect revenues, send revenues to

foreign office, maintain records, exercise voting rights, and

perform ancillary accounting functions. Major policy

decisions were determined by the foreign office. U.S.

activities do not arise to trade or business

• Spermacet Whaling and Shipping Co. v. Commissioner -

Receiving monthly statements and correspondence and

making certain payments were ministerial and did not rise to

level of U.S. trade or business. Holding board meetings in

U.S. insufficient.

20

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• Ministerial, clerical, or collection-related activities, usually not

sufficiently profit-oriented to constitute a U.S. trade or business.

(continued)

• Linen Thread Co. v. Comissioner - delivery of goods,

handling of paperwork, and collection of payment by the U.S.

office did not rise to the level of a trade or business.

21

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• Activity must be substantial. Isolated activities will generally be

insufficient.

• Linen Thread Co. v. Commissioner – two isolated transactions

insufficient to create trade or business

• However, one transaction can create a U.S. trade or business if

that activity is significant in relation to total activities

• Johansson v. United States - world championship bout by

nonresident alien in the United States constituted a U.S. trade

or business

22

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• Promotional activity (i.e., advertising) insufficient but

solicitation of business can arise to level of U.S. trade or

business

• Opening a bank account in the U.S. insufficient

• Mere purchase of goods in U.S. insufficient

23

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• Attribution through agents can cause a foreign person to be

engaged in a U.S. trade or business

• Actions of employees usually can cause foreign person to be

engaged in a U.S. trade or business

• Actions of agents that are not employees can cause a U.S.

trade or business

24

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• Personal services performed in the U.S. create a U.S. trade or

business

• Exception for:

• Nonresident individual

• Working for a nonresident alien individual, foreign

partnership, or foreign corporation, not engaged in trade

or business within the United States

• Temporarily present in the U.S. for less than 91 days, and

• Receives $3,000 or less of compensation for such

services

25

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• Trading in stock and securities through an independent agent is

insufficient to create a U.S. trade or business

• Trading in stock and securities for taxpayer’s own account is not a

U.S. trade or business

• This exception does not apply to a “dealer”

• A dealer is a merchant regularly engaged in selling stock or

securities to customers

26

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• Section 897 – A foreign taxpayer with gain or loss from the

disposition of U.S. real property interests are treated as if they

were engaged in a U.S. trade or business for the taxable year,

regardless of whether they were actually so engaged (discussed

more later)

• Attribution from partnerships and trusts (discussed later)

27

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Effectively Connected Income

• Only income that is effectively connected with a U.S. trade

or business (ECI) is subject to U.S. tax

• What is effectively connected income?

• First determine if income is “U.S. source income” or

“foreign source income”

• Second, apply ECI statutory rules and regulations

• Generally all “U.S. source income” is considered to

be effectively connected income

• If “foreign source income,” complicated rules

apply

28

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Determining U.S. Source

• Interest—Generally sourced to the residence of the payer (subject to

exceptions discussed below)

• Dividends—Generally sourced to the residence of the payer (subject

to exceptions discussed below)

• Personal Services—Generally sourced at the location where the

services are performed

• Rents and Royalties—

• Tangible property (location)

• Intangible property (use)

• Sale or Exchange of Real Property—Location (special rules for

USRPI)

• Sale or Exchange of Personal Property—Generally sourced at

residence of seller (special rules for inventory)

29

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Determining U.S. Source

• Sale or Exchange of stock—Generally sourced at residence of seller

30

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Sourcing Rule Exceptions

• Interest from “80/20 Corporations” treated as foreign source income

• Interest from deposits with a foreign branch of a U.S. corporation

treated as foreign source income

• Certain portion of dividends from foreign corporations are treated as

U.S. source if such foreign corporation has ECI that equals at least

25% of its worldwide income

31

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• Is investment income effectively connected income?

Generally yes, if one of three tests are met:

• Asset-Use Test - ECI includes income from assets

“used in or held for use in” the conduct of the foreign

corporation's U.S. trade or business

• Business-Activities Test - The activities of the U.S.

trade or business were a material factor in the

realization of the income

• Active and Material Participation Test – The income is

effectively connected with the conduct of a banking or

similar business in the United States

32

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• Can foreign sourced income be considered effectively connected

income? Generally yes, under certain circumstances:

• Foreign-sourced income from

• Intangibles,

• A banking or securities business, and

• Sales of inventory property (unless the property is sold or

exchanged for use, consumption, or disposition outside the

U.S., and (2) a non-U.S. office/fixed place of business

“participated materially” in the sale

• In each case, if the income is attributable to an “office or other

fixed place of business” within the United States.

33

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• Determining existence of office or other fixed place of

business

• Fixed Facilities - an office or other fixed place of

business is a fixed facility, that is, a place, site,

structure, or other similar facility, through which a

nonresident alien individual or a foreign corporation

engages in a trade or business

• Management activities - not considered to have an

office or other fixed place of business merely because a

person in control of business has an office or other

fixed place of business from which general supervision

and control over the policies of the business are

exercised

34

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• Determining existence of office or other fixed place of business

• Employee (or dependent agent) activities – activities of an

employee can create an office or other fixed place of business if

such employee:

• has the authority to negotiate and conclude contracts and

regularly exercises that authority,

• has a stock of merchandise belonging to the nonresident alien

individual or foreign corporation from which orders are

regularly filed, or

• employee activities take place in an employer’s fixed

facilities

• Independent agent activities – generally cannot create fixed place

of business

35

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• Determining whether foreign income is attributable to fixed place of

business:

• Office or fixed place of business must be a “material factor” in the

realization of the income

• For intangibles, office is a material factor if it either:

• actively participates in soliciting, negotiating, or performing

other activities required to arrange the lease or license that

generates the income; or

• performs significant services incident to such lease or license

36

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• For intangibles, the following activities by a U.S. office are

insufficient to cause foreign licensing income to be attributable to that

office:

• Developing, creating, producing, or acquiring and adding

substantial value to the intangible property;

• Collecting or accounting for the income;

• Exercising general supervision over the activities of the persons

directly responsible for either soliciting, negotiating, or arranging

the lease or license or performing significant services incident to

such lease or license;

• Performing merely clerical functions incident to the lease or

license; or

• Exercising final approval over the execution of the lease or

license

37

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• For inventory, the office or fixed place of business must be a “material

factor” in the realization of the income by

• actively participating in soliciting the order, negotiating the contract of

sale, or performing other significant services necessary for the

consummation of the sale, which are not the subject of a separate

agreement between the seller and the buyer, and

• the income, gain, or loss is realized in the ordinary course of the trade or

business carried on through the U.S. office or fixed place of business.

• The following activities, alone, are insufficient:

• The sale is made subject to the final approval of such office;

• The property sold is held in and distributed from such office;

• Samples of the property sold are displayed (but not otherwise promoted

or sold) in such office; or

• Such office performs merely clerical functions incident to the sale

38

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Branch Profits Tax

• Intended to tax a U.S. branch of a foreign corporation

similarly to a U.S. subsidiary of a foreign corporation

• Imposed on after-tax earnings that are not reinvested in a

U.S. trade or business by the close of the tax year

(“dividend equivalent amount”)

• 30% tax (unless reduced by treaty)

• Also, a 30% branch interest withholding tax on payments

by U.S. branch to foreign payee

39

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Branch Profits Tax Example

40

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Inbound Investments in U.S. Real Estate

Foreign Corp. A

U.S.

Blocker

Corp. 2

Foreign Corp. B

U.S. Holding

Corp. U.S.

Blocker

Corp. 1

U.S.

Blocker

Corp. 3 U.S.

Sub 1

U.S.

Sub 2

U.S.

Sub 3 U.S. Real

Estate

Venture 1

U.S. Real

Estate

Venture 2

U.S. Real

Estate

Venture 3 U.S. Real

Estate

Venture 1

U.S. Real

Estate

Venture 2

U.S. Real

Estate

Venture 3

41

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Inbound Investments in U.S. Real Estate (con’t)

No U.S. Holding Corp.

• Con: Profits and losses on

separate ventures cannot offset

each other to reduce U.S.

Operational Tax

• Pro: As each venture is sold, each

U.S. Blocker Corp. can liquidate

without U.S. WH Tax (no

Repatriation Tax in U.S.)

• More likely to be used if ventures

expected to be repatriated at

different times

U.S. Holding Corp.

• Pro: Profits and losses on separate

ventures can offset each other

within U.S. consolidated tax

return

• Con: As each venture is sold,

repatriation of proceeds may be

subject to U.S. WH Tax

• More likely to be used for

portfolio of assets with longer

expected holding periods

42

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Business Profits – Treaty Effect

• Business Profits of a resident of one country are not

taxable in the other country unless the company has a

“Permanent Establishment” (PE) in the other country

• What is a PE?

43

696244-1


• A Permanent Establishment is generally a:

• a place of management;

• a branch;

• an office;

• a factory

• a workshop; etc.

• mining facility, or any other place of extraction of natural

resources

• A building site or a construction, assembly or installation

project constitutes a permanent establishment only if it lasts

more than twelve months

• A business resulting from this combination is of a preparatory

or auxiliary character

44

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• Notwithstanding the foregoing, the following are generally not a PE:

• the use of facilities solely for the purpose of storage, display, or

delivery of goods or merchandise belonging to the enterprise;

• the maintenance of a stock of goods or merchandise belonging to

the enterprise solely for the purpose of storage, display. or

delivery;

• the maintenance of a stock of goods or merchandise belonging to

the enterprise solely for the purpose of processing by another

enterprise;

• the maintenance of a fixed place of business solely for the

purpose of purchasing goods or merchandise, or of collecting

information, for the enterprise;

• (Continued on next slide)

45

696244-1


• the maintenance of a fixed place of business solely for the

purpose of advertising, of the supply of information, of scientific

activities, or of similar activities that have a preparatory or

auxiliary character for the enterprise; or

• the maintenance of a fixed place of business solely for any

combination of activities mentioned in subparagraphs a) to e),

provided that the overall activity of the fixed place of business

resulting from this combination is of a preparatory or auxiliary

character

46

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• PE treaty provisions attempt to prevent company formed in

one treaty country from inadvertently becoming subject to

tax in the other country

• Independent Agency status vs. Dependent Agency

status

• I.e., commission agent, broker, sales agent, etc.

• Use related corporations to insulate against tax

• Enter into intercompany agreements, limiting local

authority

47

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Trade/Business Investing – Tax Reporting

IRS Foreign Corp.

No

foreign

tax? Foreign

Gov’t

U.S. Branch or U.S.

Real Estate (U.S. T/B)

Operating Income

Foreign Corp.

files U.S. tax

return and pays

U.S. corporate

income tax

IRS

Foreign Corp.

files U.S. tax

return and pays

U.S. branch

profits tax

Dividend

equivalent

Foreign Corp.

No

foreign

tax?

Foreign Corp.

files U.S. tax

return and pays

U.S. corporate

income tax and

branch profits

tax

IRS

Partnership

U.S. T/B

Distributions of

dividend equivalent

Operating Income

IRS Partnership Withholding

48

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Trade/Business Investing – Tax Reporting

(con’t)

Foreign Corp. IRS

Foreign Corp. files

U.S. tax return and

pays U.S. corporate

income tax on gain

U.S. Branch U.S. Real

Estate

Partnership

U.S. T/B

U.S. Branch Assets/

U.S. Real Estate/

U.S. Partnership Interest

Cash

Buyer

Gain on sale of the U.S. T/B will not be subject to

the Branch Profits Tax if Foreign Corporation

terminates its U.S. T/B activities in year of sale

49

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AGENDA

• Introduction




• Form 1120-F



50

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• Section 875(1)

• If a partnership is engaged in a U.S. trade or business, its foreign

partners also are treated as so engaged

• Rule applies to both general partners and limited partners

• Section 875(2)

• If a trust or estate is engaged in a U.S. trade or business, each of

its foreign beneficiaries also is treated as so engaged

51

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Disposition of Partnership Interest

• Consider treatment of income/gain from disposition

by a partnership (with foreign partners) of its US

business assets – generally, treated as ECI to the

foreign partners

• Query the treatment of income/gain from a

disposition by the foreign partner of its interest in the

partnership – is characterization determined as

aggregate or entity?

• Rev. Rul. 91-32: Stated broadly, the IRS has ruled

that gain is characterized on the basis of the ECI

attributes of the underlying partnership assets

• Capital/ordinary character (and amount) still

governed by Sections 741/751.

52

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Disposition of Partnership Interest (cont.)

• IRS analysis considers source and characterization

rules of sections 864 and 865, as well as other

provisions

• Key consideration: Capital gain is ECI if attributed to US office of

foreign partner

• US business of partnership is treated as giving rise to US

office (and PE) of foreign partner

• Ruling also holds that gain from disposition of partnership

interest is attributed to that office

• Position has been challenged by taxpayers – see,

e.g., Field Attorney Advice 20123903F

• Principles of ruling also subject of Administration’s

proposed legislation

53

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Trust ECI

• Foreign beneficiary is taxable on share of trust's income

that is effectively connected with such trade or business

• Income retains its character as business profits from a U.S.

trade or business in the hands of the foreign beneficiary

54

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AGENDA

• Introduction




• Form 1120-F



55

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Portfolio Investing (FDAP; Non-ECI)

Foreign Corp.

U.S. Corp.

Dividends

or interest

Cash investment in

stock or debt

The technical term for portfolio income is “fixed or determinable annual

or periodical” income, profit, or gains (FDAP).

Foreign Corp.

U.S. Corp.

Rent, royalties, payments

for services, etc. Contract

56

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FDAP (Non-ECI) Structure (30% Flat Tax)

Foreign Corp.

U.S. Corp.

Operating

income

Step 1:

Step 2:

U.S. corporate income tax –

Operational Tax

Step 3:

Foreign country corporate tax


Dividends or interest; U.S. Withholding Tax


Cash investment in stock or

debt Transaction Tax, if any

57

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FDAP Structure (cont’d)

Foreign Corp.

U.S. Corp.

Exit Tax in U.S.,

if any, and/or

Foreign Country

Step 4: Stock of U.S. Corp.

Buyer

Cash

58

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FDAP

• Items enumerated in statute as FDAP:

• interest,

• dividends,

• rents,

• salaries,

• wages,

• premiums,

• annuities,

• compensations,

• remunerations, and

• emoluments

59

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FDAP

• Regulations define FDAP expansively:

• FDAP includes “all income included in gross income

under Section 61 (including original issue discount), except for

the items specified” in the regulations. The “specified” items are:

• gains from the sale of property,

• a specific type of insurance premium paid to a foreign

insurer, and

• “any other income” that the Service publicly announces is

not FDAP.

• Preamble - “the statute contemplates very few exceptions to the

concept of FDAP, and the only clear exception is for gain from

the disposition of property.”

60

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FDAP

• Section 871/Treas. Reg. 1.871-10

• Foreign investors in U.S. real property can elect to treat real

property income as ECI instead of FDAP

• Benefit is that ECI permits deductions (including depreciation

expense)

• FDAP is a 30% flat tax on rent

61

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FDAP Treaty Effects

• 30% FDAP tax is subject to a lower treaty rate

• E.g., U.S.-UK Treaty - 5% dividends, 0% interest and

royalties

• Must make sure treaty benefits are available

• Limitation of benefits clauses

62

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Portfolio Investing – Tax Reporting

Foreign Corp.

U.S. Corp.

Foreign Country corporate income tax

Equity or debt Provides Form W-8 Dividends or interest, net of WH Tax;

and Form 1042-S

WH Tax and Forms 1042

and 1042-S IRS

U.S. Corporate income tax Operating

income

63

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Portfolio Investing – Tax Reporting (cont’d)

Foreign Corp.

U.S. Corp.

Stock of U.S. Corp.

Cash

Buyer

Generally no Exit Tax in U.S. on capital gains.

64

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Portfolio Interest Exception – 0% WH Tax

Debt in

“registered form”

Foreign Corp.

U.S. Corporation

• 0% WH Tax on Portfolio Interest.

• Portfolio Interest:

— “registered form” debt instrument;

— interest must not be contingent;

— must receive Form W-8;

— does not apply to:

10% owners;

interest paid to banks in the ordinary course; or

interest paid to CFCs by a related person

“Portfolio

Interest”

Form W-8

65

696244-1

AGENDA

• Introduction




• Form 1120-F






Agenda

Filing for Inbound US Business

– Form 1120-F

– Form 5472

– Form 8833

– Form 1065

Withholding Tax – Substantive Rules and Filing

Requirements

– General principles

– Key Exceptions

– Filings for Non-Business Items: Forms W-8 “family”; Form 1042

– Filings for Business Items: Form 8288 (FIRPTA); Form 8804

(Partnership ECI)

66

Filing for Inbound US

Business

67

General Background

68




Return Filing by Foreign Corporations

General Requirements for Form 1120-F

– Engaged in trade or business in U.S. (ETB)

– Treated as engaged (e.g., “FIRPTA”)

– Claim of Treaty Relief (Section 6114; Reg. sec. 301.6114-1(b))

• Certain Exceptions (Reg. sec. 301.6114-1(c))

• Penalties for failure to file – Section 6712 ($10,000 foreign corps, $1,000 others)

Generally, not required if only income is non-business

FDAP, withholding satisfied, and no claim of treaty

Sanctions for failure to file Form 1120-F

– Section 882(c): Loss of deductions and credits

– Statute of limitations does not commence until filing

Protective Return – only base information required

– To preserve deductions and start statute of limitations (Reg. sec.

1.882-4)

69




FIRPTA: Filings Often Required Even if No U.S. Tax

Non-USRPI Certification

– Must rebut presumptions that stock of U.S. corporation is USRPI –

Reg. sec. 1.897-2(g), (h)

Notice of Nonrecognition Transactions

– FIRPTA generally overrides nonrecognition – Section 897(d) and (e)

– Substantive and procedural requirements under Reg. sec. 1.897-2(g)

and (h) and, Reg. sec. 1.1445-2

Consequences for Failure to Make Required Filings

– Exceptions from withholding do not apply

– Withholding agent liability for taxes, penalties and interest

• Potential liability for interest even if no tax – Reg. sec. 1.1445-1(e)(2)(ii)

– Foreign shareholder must file tax return – Reg. sec. 1.897-2(g);

Notice 89-57

70




71

TINs for Foreign Persons

IRS Requires TINs More Often and Sooner

– Reduce or Avoid Chapter 3 Withholding – Required for Most Treaty

Benefits: Form W-8BEN, Form W-8BEN-E

• May use US or foreign TIN beginning in 2014 (Reg. sec. 1.1441-

6T(c)(2))

– FIRPTA

• Withholding Certificate Applications: Form 8288-B (US TIN)

• Nonrecognition or Non-USRPI Filings

• Seller/Transferor must provide TIN to Buyer/Transferee

› Form 8288 Proof of Payment for Credit or Refund

– Entity Classification Elections (Check the Box): Form 8832




72

TINs for Foreign Persons

IRS Requires TINs More Often and Sooner (cont’d)

– Return Filing

• E.g., Engaged in trade or business in U.S. (ETB) during year, regardless

whether ECI arises

• Form 5472, Part II (25% Foreign Shareholder), Part III Related Party

• Protective Return Filing (Reg. sec. 1.882-4), e.g., not otherwise ETB

– Treaty Return Position Disclosure (Section 6114)

• Form 8833 attached to return

Foreign Entities Apply Using Form SS-4 (EIN)

– Nominees not allowed as responsible party on application




Unique Reference Identification Numbers

Unique Reference Identification Numbers (URI or

Reference Identification Number)

– See Instructions to forms related to reporting as to certain foreign

entities

• E.g., Forms 5472, 5471, 8861, 8865, 8858, 926

– Mandatory after 2012 if no U.S. EIN for foreign entity

• Can include both EIN and URI

• http://www.irs.gov/Businesses/Corporations/New-Identification-Number-

Implemented-for-Certain-Foreign-Information-Returns

73

http://www.irs.gov/Businesses/Corporations/New-Identification-Number-Implemented-for-Certain-Foreign-Information-Returns

















Form 1120F, U.S. Income

Tax Return of Foreign

Corporation

74




75

Form 1120-F




76

Reporting of Income and Expense

Ultimately, all of the technical and factual considerations

reviewed earlier in this discussion boil down to a number

inserted into a box on these forms.

Special rules apply to interest expense, and a foreign

corporation with ECI must to follow the general rules

governing interest deductibility and its limitations, including

§ § 163(j) and 267(a)(2)/(3)

Consideration also must be given to the determination of

Branch Profits Tax and Branch Level Interest Tax

– Appropriate tax treaty disclosures also must be filed with the return

Finally, any intercompany transactions are governed by §

482 transfer pricing provisions




Form 1120-F – Due Date

Similar to US corporations, file by 15th day of the third

month after the end of the tax year

– Form 7704, Application for Automatic Six-month Extension of Time

to File Certain Business Income Tax Returns

• Generally due on original due date; but, foreign corporation has “free”

additional extension to 15th day of sixth month to file Form 7704 (§ 6081

and Reg. sec. 1.6081-5). NOTE: Max extension still only six months

from original due date

– Tax due on original due date

If no office or place of business in the U.S.

– Form 1120F is due on the fifteenth day of the sixth month after the

end of the foreign corporation’s tax year or file an extension

• File Form 7004 for additional three-month extension from

– Tax still due on original due date (15th day of third month)

77




“Earnings Stripping” or “Thin Cap” Rules:

§ 163(j)

What is earnings stripping?

– Foreign parent may try to “strip” earnings out of its U.S. subsidiary

by having subsidiary pay deductible interest, rather than dividends,

thus avoiding U.S. taxation of subsidiary earnings and often

reducing U.S. withholding tax

§ 163(j) applies if a corporation has:

– A ratio of debt to equity exceeding 1.5 to 1, and

– “Excess interest” expense

– “Excess interest” equals:

• Net interest expense over

• 50% of corporation’s income before interest, taxes, depreciation, and

amortization

78




“Earnings Stripping” Rules: § 163(j) (Cont’d)

What does § 163(j) do?

– Applies to disallow “disqualified interest” (either one of two types)

• Interest paid to related parties if no tax imposed (tax-exempt payee or

withholding tax reduced by treaty)

• Interest guaranteed by related party and paid to third parties if no gross

basis tax is imposed (e.g., withholding tax reduced by treaty)

The amount of interest disallowed is the lesser of the “excess interest”

expense or the “disqualified interest”

Special Rules

– Carryforward disallowed interest (indefinitely)

– Carryforward excess limitation (three years)

– Complicated rules if have U.S. affiliated group

Filing: Form 8926, “Disqualified Corporate Interest Expense Disallowed Under

Section 163(j) and Related Information”

79




80

Section 163(j): Form 8926

Computations on Form 8926 Follow Statute Instead of Proposed 163(j)

Regulations

– Documents the following relevant elements of the determination

• Debt-Equity Safe Harbor

• Net Interest Expense

• Adjusted Taxable Income

• Identity of Related Persons Receiving Interest

• Carryforwards (disallowed interest; excess limitation)

– Form is required even if no disallowed deduction




81

IRC § 482—Overview

Transfer price—amount charged in transaction between

commonly controlled businesses

– E.g., sale of goods, provision of services, loans, rental/license of

property

Significance

– Potential for shifting income between US and non-US

Authorizes IRS to re-allocate income and deductions

among taxpayers under common control to prevent tax

evasion or clearly reflect income

Arm’s length standard must be applied

Substantial penalties where application of § 482 by IRS

results in underpayments

Form 5472,

25% Foreign-Owned

U.S. Corp or Foreign

Corp with Effective

Trade or Business

82




Form 5472

83




84

Form 5472 Information Return

The Form 5472 filing requirements apply to:

– 25% foreign-owned U.S. corporations (section 6038A)

– Foreign corporations engaged in a U.S. trade or business at any

time during year (section 6038C)

A U.S. corporation is “25% foreign-owned” if at any time

during the taxable year a foreign person owns at least

25% of its stock by vote or value

– Modified section 318 attribution rules apply

A separate Form 5472 must be filed for each (U.S. or

foreign) “related party” with which the reporting corporation

has a “reportable transaction” during the year

– More information required for foreign related transaction

• Parts IV and V




Form 5472—Consolidation

If a reporting corporation is a member of an affiliated group

then a consolidated Form 5472 is permitted

The common parent must attach to Form 5472 a schedule

stating:

– Members of the U.S. affiliated group that are reporting corporations

– Which of those members are joining in the consolidated filing of

Form 5472

– The name, address, and employer identification number of each

member who is including transactions on the consolidated Form

5472

85




86

Form 5472—Due Date

Due Date

– Due date with the reporting corporation’s U.S. income tax return

ILM 200429007—Form 5472—Substantially Incomplete

Return

Partnerships and ECI

87




88

Common Filing Issues: Foreign Partnerships

Foreign Partnerships

– Forms W-8IMY and W-8 or W-9 for partners, plus allocation

required to claim Treaty benefits on FDAP paid to foreign

partnership. See Instructions to Forms W-8BEN, W-8BEN-E

– Form 1065 – filing requirements

• Reg. sec. 1.6031(a)-1(b)

– Section 1446 – filing requirements

Foreign Hybrid Entities – See Instructions to Form W-

8BEN

– W-8BEN, or W-8BEN-E if claiming Treaty benefits on own behalf

– W-8IMY if claiming Treaty benefits of its Owner




89

Foreign Partnerships - Form 1065 Partnership

Return

Form 1065 is used by both U.S. and foreign partnerships

Generally, a foreign partnership files Form 1065 if it has

gross income that is (Reg. sec. 1.6031(a)-1):

– effectively connected to a trade or business within the U.S.

or

– derived from sources within the U.S.

A foreign partnership required to file Form 1065 generally

must report all of its foreign and U.S. source income (Form

1065 Instructions)

A foreign partnership filing Form 1065 solely to make an

election need only provide its name, address, and EIN on

page 1 and attach the appropriate statement.




90

Form 1065 – Exceptions To Filing by Foreign

Partnerships

Exceptions to Filing (Reg. sec. 1.6031(a)-1(b)(2) and (3)):

– Foreign partnerships that has U.S. source income equal to or less than $20,000 and has no ECI

• And only if:

› Less than 1% of any partnership item of income, gain, loss, deduction, or credit was allocable to direct U.S. partners

– Foreign partnership that has U.S. source income, but has no ECI and no U.S. Partners

• All required Forms 1042 and 1042-S were filed,

• The tax liability of each partner was withheld at the source (if applicable), and

• Not a withholding foreign partnership.

• Note: U.S. Partners may be required to provide statements, etc.

Other foreign partnerships with no ECI may have modified filing obligations

– E.g., filing Form K-1 only for direct U.S. and U.S. or foreign passthrough partners: Reg. sec. 1.6031(a)-1(b)(3)(iii)




91

Foreign Partnerships – Section 1446 Withholding

Tax Filing Requirements

Section 1446: US and foreign partnership must withhold and file returns to report ECI allocable to foreign partners

– Identify withholding rates on Form 8804

– Trumps Section 1445(e)(1) Withholding by Partnerships

– Form 8813 – Partnership Withholding Tax Payment Voucher (Section 1446) (Quarterly deposits based on partnership year)

– Form 8804 – Annual Return for Partnership Withholding Tax (Section 1446)

– Form 8805 – Foreign Partner’s Information Statement of Section 1446 Withholding Tax

– Form 8804 Sch. A – Penalty for Underpayment of Estimated Section 1446 Tax by Partnerships

– Form 8804-C – Certificate of Partner-Level Items to Reduce Section 1446 Withholding

– Form 8804-W – Installment Payments of Section 1446 Tax for Partnerships (Worksheet – not filed)

Treaty Return Position

Disclosures – Section

6114

92




93

Common Filing Issues: Treaty Return

Position Disclosures – Section 6114

Treaty Return Position Disclosures – § 6114

– Form 8833 – Treaty-Based Return Position Disclosure Under

Section 6114 or 7701(b)

• Annual

– Reg. section 301.6114-1(b) specifically requires reporting of

reduced withholding on certain FDAP payments

• Overrides Reg. sec. 1.6012-2(g)(2)(i) exemption from filing Form 1120F

when not ETB and tax fully withheld at source

• Many FDAP exceptions added, but other requirements remain

› $500,000 De Minimis Exemption - Reg. sec. 301.6114-1(c)(8)

› Section 6038A Exemption – Reg. sec. 301.6114-1(c)(6)




94

Common Filing Issues: Treaty Return Position

Disclosures – Section 6114

Reg. section 301.6114-1(b) specifically requires reporting of the following non-FDAP treaty-based return positions, including:

– Treaty nondiscrimination provision precludes application of Code provision (other than certain aspects of section 897(i))

– Treaty reduces or modifies taxation of a U.S. real property interest

– Treaty exempts or reduces branch profits tax (section 884(a)) or the tax on excess interest (section 884(f)(1)(B))

– Treaty exempts from, or reduces, U.S. tax on certain U.S. source interest or U.S. source dividends paid by a foreign corporation

– No permanent establishment and therefore exempt from U.S. tax on ECI

– Treaty alters the source of income or deduction

– Treaty grants foreign tax credit not allowed under the Code

– Residency of an individual is determined under a treaty not Code

– Certain related party FDAP payments and if “other” treaty requirements

95

696244-1

AGENDA

• Introduction




• Form 1120-F



Withholding and

Associated Reporting

96




97

Review From Earlier Discussion – US Taxation of

FDAP Income

Generally, U.S. source investment income

– Certain exceptions apply

Taxed on gross basis

Tax rate generally = 30%

– Or lower treaty rate

Generally collected through withholding at source




98

FDAP Income Defined

Fixed or determinable annual or periodical income

– Does not mean actually recurring

– Descriptive of character of the income

– Generally includes:

• Interest, OID, dividends, rents, royalties

– Payments received may vary in amount and frequency

• E.g., series of payments or lump sum




FDAP Income—Summary

Item Exceptions to U.S. Withholding Tax

Interest

(including

unstated

interest & OID)

1. Interest constituting ECI

2. “Portfolio interest,” i.e., most interest on debt instruments held by

foreign persons in either registered or bearer** form other than:

a. Interest payable to a 10% or more owner (with test applied at

partner level in case of debt held by a partnership)

b. Interest payable to a bank on a loan

c. Interest received by a CFC from related persons

d. Contingent interest

3. Interest on obligations with original maturity of 183 days or less

4. Interest on deposits with banks and S&Ls

5. Tax-exempt interest

6. Interest paid by 80/20 company (Note repeal of 80/20 rule for post-

2010 years subject to grandfather rule)

** NOTE: For obligations issued after 3/18/12, “bearer” exception is no longer available.

99




FDAP Income—Summary (Cont’d)


Dividends

(Cash or

Property)

1. Dividends constituting ECI

2. Ratable portion of dividends of domestic corporation deriving 80%+ of

gross income from active foreign business (Note repeal of 80/20 rule

for post-2010 years subject to grandfather rule)

3. Dividends paid by a foreign corporation deriving 25%+ of its income

from a U.S. business (treated as USSI under sourcing rules)

4. “Interest-related dividends” paid by RICs (i.e., dividends attributable to

portfolio interest, bank deposit interest, short-term OID) other than:

a. Amounts paid to 10% shareholder

b. Where payee fails to provide Form W-8BEN

c. Where payee is resident of “blacklisted” country

d. Certain amounts paid to a CFC

5. STCG dividends paid by RICs

100




FDAP Income—Summary (Cont’d)


Royalties

(including

contingent

payment sales)

1. Amounts constituting ECI

2. “Net consideration method” for “qualified patent cross licensing

arrangements”

Rents 1. Amounts constituting ECI

2. Real property income that taxpayer elects to treat as ECI

3. 10% withholding on gross proceeds from sale of USRPI

Salaries &

wages


2. De minimis amounts (< $3,000)

Gross income

from annuities


101




Payments to Partnerships

Domestic partnerships

– Generally, no withholding on payment to partnership

– Partnership withholds on foreign partners’ distributive shares of

FDAP income

• Withholding on earlier of date FDAP is distributed to foreign partner or

original due date for Form 1065/K1 filing (or, if earlier, actual filing of

forms). Reg. sec. 1.1441-5(b)(2)

Foreign partnership

– Generally, withholding required on payment to a foreign partnership

– Exception (full or part relief) if foreign partnership has entered into

agreement with IRS that it will withhold on foreign partners’

distributive shares (e.g., certain institutional funds), or Forms W-

8IMY filed by foreign partnership with accompanying Forms W-8 or

W-9 for its partners. See instructions to Forms.

102




Filing Obligations

Payees (to reduce potential WHT)

– Form W-8ECI—effectively connected income

– Form W-8BEN or W-8BEN-E—lower treaty withholding rates

– Form W-8EXP—foreign government exception

– Form W-8IMY—foreign intermediary

– Keep in mind FATCA overlay to all of the above (more below)

– Also, Form W-9 for US payees

Payors

– Form 1042—withholding tax return

– Form 1042-S—foreign person’s U.S. source income subject to

withholding

– Form 1042-T—Form 1042-S transmittal

103




Section 1441/1442 Overview and Recent

Developments

IRS routinely requesting Form 1042 Related Information in

Course of Audits

IRS Compared Forms 5471 and 5472 With IRS Form 1042

Database

– IRS is contacting filers of Forms 5471 and 5472 that did not file

Form 1042

FATCA Enacted in 2010

– New withholding rules (new Chapter 4) for payments to foreign

entities

• In addition to Chapter 3 Withholding (Sections 1441, 1442, etc.)

• New coordination rules (Chapter 4 generally takes priority over Chapter

3)

104




105

IRS Now Has Significant Interest in 1441

Compliance

“New” Section 1441 Regulations Released in 1997

(Effective for Payments after 1/1/2001) ; Amended 2014

for FATCA Coordination

– Key to New Regulations is Documentation

• Family of Forms W-8 (W-8BEN; W-8BEN-E; W-8IMY; W-8ECI; and W-

8EXP)

› Due Diligence Requirements (No conflicting information with claims made)

› Mandatory Presumption Rules Where Documentation is Missing or Invalid

– More IRS examiners as a result of FATCA Chapter 4

implementation and enforcement

• Likely focusing on Chapter 3 issues, too

FAQ 1: What about the

new forms?

106




Form W-8BEN-E [Used by Entities]

Part I, Line 5, FATCA Classification

107

Withhold 30% unless

FATCA withholding

exception applies

May commonly see from

financial payees. Will need

to check GIIN on the IRS

website.

US or foreign income tax ID

number is necessary for

treaty relief

May commonly see from

nonfinancial vendors. If

direct reporting NFFE, will

need to check GIIN on the

IRS website.




Form W-8BEN-E

Part III Treaty Claim (Retained From Prior Version)

108

Necessary for treaty

claims (along with

US or foreign

income tax ID

number noted on

page 1)

For claiming special

rates




Form W-8BEN-E

Supporting FATCA Representations

109

If this box is

checked, the

ownership

disclosures on the

last page should be

completed.

Common

nonfinancial vendor

classifications must

also be supported

by representations

(Supplements

status shown on line

5)




Form W-8BEN-E

Required Certifications

110

Must be

completed; form

generally expires

in 3 years

Must be checked

in all cases

If item 40(c) is

checked, this table

must be completed

(including TINs)

FAQ 2: What am I

supposed to do with

the new Form 1042-S?

111




Form 1042-S

112

US Parent

Corporation

Foreign

IP Co

US source

royalties

FATCA reporting applies to all kinds of “typical” payments, although some

may be eligible for exceptions from withholding:

US

OpCo

Foreign 3P

Vendor

Interest on

product-

related A/P

Foreign

Bank

US source

interest

US source

dividends

and (post-

2016) stock

redemption

proceeds

Foreign 3P

Law Firm

Foreign

Shipper

US source

services

fees US risk-

related

premiums

public

Foreign

Insurer

International

shipping fees




Form 1042-S

113

Common Ch 4 exemption codes:

• 14 – Effectively connected Income

• 15 – Payee not subject to chapter 4 withholding

• 16 – Excluded nonfinancial payment

• Ties to status noted on W-8BEN-E

• NOT required if the payment is eligible for a

withholding exception

• If no other payment-related exemption applies and line

13i filled in, exemption code 15 (payee not subject to

ch 4 withholding) should be used

US TIN or foreign

income tax ID number

necessary to claim treaty

benefit

Common Ch 3 exemption codes:

• 01 – Effectively connected Income

• 04 – Exempt under tax treaty

• 12 – Payee subjected to chapter 4

withholding




Form 1042-S

114

Payment Type

Form

1042-S

Required?

Ch. 3

Applies?

Ch. 4

Exemption

Code

Required

(line 4a)?

Ch. 4 Payee

Status Code

Required

(line 13i)?

Payment for goods (not FDAP) no no no no

Interest on late payment for goods yes yes yes

(code 16)

no

Gross transportation proceeds subject to section 887 excise tax no no no no

Shipping subject to section 883/income tax treaty yes yes yes

(code 16)

no

Insurance premiums subject to excise tax (valid Form W-8BEN-

E provided (except NPFFI))

no no no no

Insurance premiums subject to excise tax (NPFFI payee/no or

invalid Form W-8BEN-E provided)

yes no yes

(enter “00”)

yes

Royalties yes yes yes (code

16)

no

Contingent payments for purchase of IP yes yes yes

(code 15)

yes

If a payment is either subject to reporting for chapter 3 purposes, or subject to

withholding for FATCA purposes, it has to be reported on a 1042-S. Examples:

115

696244-1

AGENDA

• Introduction




• Form 1120-F



116

696244-1

Portfolio Investing With Numbers – Equity

Foreign Corp.

U.S. Corp. U.S. Tax 35

Income 100

Dividend 65.00

WH Tax (19.50)

45.50

U.S. Corp.

Income 100

U.S. Corp. Tax (35)

After-tax Income 65

Foreign Corp. (U.S. Tax)

Dividend Income 65.00

(U.S. WH Tax 30%) (19.50)

Net Received 45.50

Foreign Corp. (Foreign Tax)

No foreign income tax if permitted

exclusions and/or foreign tax credits

eliminate foreign tax

117

696244-1

U.S. T/B Investing With Numbers – Equity

Foreign Corp.

U.S. Branch or

U.S. Real Estate

U.S. Partnership

with U.S. Branch

or U.S. Real

Estate U.S. Tax 35

ECI Income 100

Foreign Corp. (U.S. Tax)

Income 100

U.S. Corp. Tax (35)

Branch Income 65

Dividend Equivalent 65.0

Branch Profits Tax (19.5)

Net Received 45.5

Foreign Corp. (Foreign Tax)

No foreign income tax if permitted

exclusions and/or foreign tax

credits eliminate foreign tax

Dividend Equivalent 65.0

Branch Profits Tax (19.50)

45.50




Notice

The following information is not intended to be “written advice concerning one or more Federal tax

matters” subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230.

The information contained herein is of a general nature and is not intended to address the circumstances

of any particular individual or entity. Although we endeavor to provide accurate and timely information,

there can be no guarantee that such information is accurate as of the date it is received or that it will

continue to be accurate in the future. No one should act on such information without appropriate

professional advice after a thorough examination of the particular situation.

118




Dated Material

THE MATERIAL CONTAINED IN THESE COURSE

MATERIALS IS CURRENT AS OF THE DATE PRODUCED.

THE MATERIALS HAVE NOT BEEN AND WILL NOT BE

UPDATED TO INCORPORATE ANY TECHNICAL CHANGES

TO THE CONTENT OR TO REFLECT ANY MODIFICATIONS

TO A TAX SERVICE OFFERED SINCE THE PRODUCTION

DATE. YOU ARE RESPONSIBLE FOR VERIFYING

WHETHER OR NOT THERE HAVE BEEN ANY TECHNICAL

CHANGES SINCE THE PRODUCTION DATE AND WHETHER

OR NOT THE FIRM STILL APPROVES ANY TAX SERVICES

OFFERED FOR PRESENTATION TO CLIENTS. YOU

SHOULD CONSULT WITH WASHINGTON NATIONAL TAX

AND RISK MANAGEMENT-TAX AS PART OF YOUR

DUE DILIGENCE.

119

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