Inbound Taxation Critical Analysis - Essay Example

?TX 604 Spring Assignment 4 Inbound & Outbound Due April 15th @4:00pm Email to sthoma1@bentley.edu Inbound Taxation Please read the following fact patterns and answer the questions that follow. John Doe, Flick’s tax director has contacted you. Some of the officers of one of Flick’s foreign subsidiaries have been calling him to ask a variety of US tax questions based on their (the officers – not the subsidiary) increased activity in the US. Please read the fact patterns carefully and respond to John Doe with answers to each of his questions. Individual One Based on some recent investment advice Joe T. decided to invest in stock through the New York Stock Exchange. He purchased 1,000 shares of common stock in IBM Corporation1 (this represents less than 1% of the outstanding voting power and value of IBM Corporation). IBM Corporation pays a regular quarterly dividend on the stock. Your previous research concluded that Joe T. is a nonresident alien of the US. 1. Is the income received US source income or foreign source income? What statute did you rely on for your conclusion(s)? Facts Joe T. is a non resident alien of the United States who has invested in 1,000 shares of common stock in IBM Corporation. IBM is registered in Delaware, United States and does most of its business within the United States. The stock owned by Joe T. represents less than 1% of the overall value of IBM Corporation. Interpretation Joe T. is a non resident alien in the United States which means that Joe T.’s income derived from sourced within the United States are liable to taxation. Since IBM Corporation executes most of its business from within the United States, so under Sections 861(a)(2) and 862(a)(2), the dividends released by such businesses are considered as income being derived from within the United States. In addition, under Sections 871 and 881, any foreign persons who have a passive form of investment, such as stock purchased within a company, within the United States are liable to a flat tax rate of 30% on such income. Under Section 871(a)(1), any income derived from various sources including dividends is liable to taxation since it is considered as income of a foreign person derived from sources within the United States. On another note, since dividends from purchased stock do not fall under any exception based category under Section 871(1), so income derived from such sources is liable to tax. 2. If the income is US source income, is it taxable income to the individual (i.e., is there an exemption or exclusion available)? What statute did you rely on for each of your conclusions? Facts Joe T. is a non resident alien of the United States who has invested in 1,000 shares of common stock in IBM Corporation. IBM is registered in Delaware, United States and does most of its business within the United States. The stock owned by Joe T. represents less than 1% of the overall value of IBM Corporation. Interpretation Most forms of income derived from sources within the United States are liable to taxation even if a non resident alien owns benefits from such sources. However, under certain circumstances exceptions may be provided to foreign investors in the United States as per taxation on income. No deductions may be taken on a foreign investor’s income from sources within the United States if it is covered by either Section 873 or Section 882(c). Income derived from a United States trade or business is exempt for taxation for foreign individuals but this applies to gross income only which does not apply to Joe T.’s case. On another note, dividends are clearly mentioned as being taxable for foreign persons under Section 871(a)(1) which makes Joe T.’s income liable to taxation. Exceptions to the current rule exist if the source of the income derived from the United States is either interest from a bank or other fiscal institution (under Section 871(i)) or if it is portfolio interest (under Section 871(h)). Joe T. may be provided with some relief, but not a complete exemption, under US Model Treaty Article 10(2). Under the subject article, the income of foreign individuals may be discounted for taxation if a bilateral treaty exists between the individual’s nation and the United States. 3. After completing all your research and addressing the questions above, you discover that Joe T. is a resident of a country that has a treaty with the US. The treaty has the following provision: Dividends paid by a company that is a resident of the contracting state to a resident of the other contracting state may be taxed in the contracting state of which the company paying the dividends is a resident. However, the tax so charged shall not exceed 15% of the gross amount of the dividends. How does this treaty provision change your answer with respect to the imposition of tax on the dividends by the US? Facts Joe T. is a non resident alien of the United States who has invested in 1,000 shares of common stock in IBM Corporation. IBM is registered in Delaware, United States and does most of its business within the United States. The stock owned by Joe T. represents less than 1% of the overall value of IBM Corporation. Joe T.’s country and the United States have a bilateral treaty regarding taxation of dividend income such that the maximum tax rate cannot exceed 15%. Interpretation As per Section 871(a)(1), the dividend based income of a foreign national derived from a United States source is liable to taxation. The rate of taxation on such income depends mainly on whether the individual is being charged a flat tax rate or if exceptions to such a rule exist. In case that a flat taxation rate is being charged on such income, the individual in question has to pay the relevant amount as tax as determined by United States law. However, in the case of an exception such as the existence of a bilateral treaty between the United States and the concerned individual’s parent nation, the rate of tax is reduced. The reduction in the amount of tax depends mainly on the treaty executed between the United States and the concerned individual’s nation. Various discount rates tend to apply in regards to various nations with whom bilateral treaties exist. Under US Model Treaty Article 10(2), dividends can be taxed at a maximum of 15% and a minimum of 5% in case that a bilateral treaty exists. In the current case, Joe T.’s country has a bilateral treaty with a maximum taxation rate of 15% which shall apply on the dividend income from IBM Corporation. Individual Two Prior to coming to work for Flick, Amy G. traveled to the US to provide management consulting services for her US client in her capacity as an employee of the Bentley Consulting Group, a Foreign Corporation. Bentley Consulting Group does not have a permanent establishment in the US. Amy G. worked in the US for a total of 40 days and her total working days for the year were 240. Amy spent 50 total days in the US (40 working days and 10 non-working days). Amy was paid a salary of $250,000 for the taxable year. Your previous research concluded that Amy G. is a nonresident alien of the US. 1. Is the income received US source income or foreign source income? If so, how much? What statute did you rely on for your conclusion? Facts Amy G. was in the United States for a total of fifty days such that forty days were on the job while tend days were off the job. The concerned individual provides services to a corporation executing business within the United States. Additionally, Amy G. was paid $250,000 in compensation for the entire taxable year. Interpretation Amy G. in her current circumstances has been working in the United States in the capacity of a non resident alien. Her income has been derived from sources within the United States making her income taxable. Amy G. has been working for a foreign corporation incorporated and executing business inside the United States. In case that a business has been generating profits inside the United States, the income of the subject business is liable to taxation as per applicable law since such income is from a United States source. Amy G. has been working for a corporation that is itself taxable inside the United States, so this in turn makes Amy G. liable to tax for her income within the United States working as a non resident alien. In case that a non resident alien’s income has to be taxed inside the United States for being income derived from United States sources, the income has to be greater than $3,000 under Section 861(a)(3). This implies that Amy G. must have worked inside the United States and should have earned more than $3,000 to be eligible for being taxed inside the United States. In addition, typically a flat rate of 30% is applied to income derived in the United States by foreign individuals working as non resident aliens. 2. If the income is US source income, is it taxable income to the individual (i.e., is there an exemption or exclusion available in either the Internal Revenue Code or Treasury Regulations)? What statute did you rely on for your conclusion? Facts Amy G. was in the United States for a total of fifty days such that forty days were on the job while tend days were off the job. The concerned individual provides services to a corporation executing business within the United States. Additionally, Amy G. was paid $250,000 in compensation for the entire taxable year. Interpretation The income of non resident aliens working inside the United States such that the income has been derived from sources within the United States is liable to taxation. When such taxation occurs, it is deemed to occur on the entire amount of income that has been derived from sources within the United States. However, the level of complications involved in determining the exact trade or business being taxed, the amount of income that should be taxed etc. mean that taxation varies from one case to the other. Under certain circumstances, the income of foreign non resident aliens derived from sources within the United States is subject to certain exemptions and reductions. However, again no particular definition of such exemptions tends to exist in either the Internal Revenue Code or in the Treasury Regulations. The facts and circumstances of each case are considered on a case to case basis to decide if a foreign individual is involved in trade and business inside the United States as expounded by Treasury Registration Section 1.864-2(e). Additionally, as per Higgins v. Commissioner, it is clear that any firm or business operating within the United States and making a profit is liable to taxation but any exemptions or reductions shall be looked into on a case by case basis. 3. If you concluded that the income constitutes US source income, please tell me if the income is subject to the flat rate tax or graduated rates. And, of course, tell me which statute you relied on for you conclusion. Facts Amy G. was in the United States for a total of fifty days such that forty days were on the job while tend days were off the job. The concerned individual provides services to a corporation executing business within the United States. Additionally, Amy G. was paid $250,000 in compensation for the entire taxable year. Interpretation Any foreign individuals involved in economic activities inside the United States are liable to taxation. The tax rates and any exemptions or reductions tend to be decided on a case to case basis. In the case of Amy G., her profession provides services inside the United States which makes her eligible for taxation. Under Section 864(b)(1), any foreign individual involved in the performance of any services is considered to be a trade or business which is liable to taxation. In Amy G.’s case, a flat rate tax would have applied if the income derived inside the United States was essentially a salary, remuneration, compensation or some other form of fixed or determinable annual of periodic (FDAP) gain. In contrast Amy G. is acting in her current capacity as a consultant and so her income derived from inside the United States fails to be covered under any of these categories. It could be argued that Amy G. is being provided remuneration for her services but determining the exact amount of such remuneration would be hard since the individual and the foreign corporation could be hiding facts. Hence, it would be more appropriate to consider Amy G.’s income derived in the United States from United States sources as being outside of remuneration but rather as being connected to a trade or business inside the United States. Under Section 871(a)(1), Amy G. would have been taxed at a flat rate tax of 30% if her income from within the United States fell into any one of the categories above. Since Amy G.’s income does not lie in any of the categories mentioned under Section 871(a)(1), so her taxation rate would not be flat but rather it would be graduated. 4. After completing all your research and addressing the questions above, you discover that Amy G. is a resident of a country that has a treaty with the US. The treaty has the following provision: Remuneration derived by a resident of a contracting state in respect of an employment exercised in the other contracting state shall be taxable only in the resident contracting state if all of the following conditions are met: a) The recipient of the salary is in the nonresident jurisdiction for less than 183 days; b) The salary is paid by a company that is not a resident of the nonresident jurisdiction; and c) The company that pays the salary does not have a permanent establishment in the US. How does this treaty provision change your answer with respect to the imposition of tax on the salary earned by Amy G. for services provided in the US? Facts Amy G. was in the United States for a total of fifty days such that forty days were on the job while tend days were off the job. The concerned individual provides services to a corporation executing business within the United States. Additionally, Amy G. was paid $250,000 in compensation for the entire taxable year. The United States and Amy G.’s parent nation have a bilateral treaty that provides for taxation exemption and reduction for foreign individuals operating inside the United States to gain income from United States sources. Interpretation Any foreign individuals operating inside the United States are liable to tax except when exemptions or reductions tend to apply. In the current case, Amy G.’s parent nation has a bilateral taxation reduction and exemption treaty. Since such treaties tend to depend from nation to nation and from case to case, so the treaty provisions need to take precedence on other applicable taxation laws in the manner that they have been laid out. The treaty provides that the individual must be present in the nonresident jurisdiction for less than 183 days when receiving a salary. Amy G. was present in the United States for a total of fifty days out of which she worked for forty days which is less than 183 days. The next provision states that the salary must be paid by nonresident company. In the current situation, Amy G. has been paid by foreign corporation acting inside the United States. The treaty does not provide if the foreign corporation needs to be from the concerned individual’s parent state or not so it is assumed that any foreign corporation would fit this bill. Amy G. has been paid by a foreign corporation so this provision of the treaty stands satisfied as well. The last provision of the treaty states that the foreign corporation should not have a permanent establishment inside the United States. In the current case, this is also true and hence all the provisions of the treaty are being met. Given that the provisions of the bilateral taxation treaty are being met, Amy G. is subject to taxation in the United States as per the subject treaty. Outbound Taxation Subpart F On January 1, 2010, Flick2 formed a wholly-owned subsidiary3 in Country X, a foreign jurisdiction with a tax rate of 25%. Flick owns all of the stock of the newly formed corporation, Flick Sales, Inc. Flick manufactures lighters in the US, sells those lighters to Flick Sales, Inc., and Flick Sales, Inc. resells the lighters to customers in other foreign jurisdictions. In 2010, Flick Sales, Inc. earned $5 million of net income from sales to Country Y. Country Y’s tax rate is also 25%. Flick Sales, Inc. has current earnings and profits of $5 million for the 2010 taxable year. 1. Is Flick Sales, Inc. a controlled foreign corporation? What statute(s) did you rely on for your conclusion? Facts Flick Sales Inc. is owned wholly by Flick. The new corporation has been set up in Country X with a tax rate of 25%. All stock of lighters is bought from Flick while it is sold to Country Y, where the tax rate is 25% as well. For the 2010 tax year, the total earnings from sales of Flick Sales Inc. were $5 million. Interpretation In the current circumstances, the entire stock of Flick Sales Inc. in Country X is owned by Flick that is incorporated in the United States. For the purposes of tax, the status of Flick can be seen as a person in the United States. According to Section 957(a), any foreign corporation whose stock is owned more than 50% by United States nationals such that at least 10% stock is under the ownership of a single person, is subject to tax in the United States for its business income. This section tends to apply if the ownership of stock of any such foreign corporation by a United States individual has been valid for only one day of the year. In the current case, Flick Sales Inc. is wholly owned by Flick United States so the stock ownership clause is satisfied. In addition, the ownership has been with Flick United States for more than one day of the 2010 tax year. Hence, it could be surmised with ease that Flick Sales Inc. is a controlled foreign corporation (CFC). 2. Do the Flick Sales, Inc. sales constitute subpart F income? What statute(s) did you rely on for your conclusion? Facts Flick Sales Inc. is owned wholly by Flick. The new corporation has been set up in Country X with a tax rate of 25%. All stock of lighters is bought from Flick while it is sold to Country Y, where the tax rate is 25% as well. For the 2010 tax year, the total earnings from sales of Flick Sales Inc. were $5 million. Interpretation Flick Sales Inc. tends to purchase its stock from Flick United States and then sells it over to another country. The transactions between Flick Sales Inc. and Flick United States constitute economic relations and hence the income derived from Flick Sales Inc. can be seen as the income of Flick United States. Flick Sales Inc. is a CFC owned by Flick United States so any income derived by Flick Sales Inc. can be considered as a foreign base company sales income (FBCSI). For taxation to apply, the stock being sold must be either be purchased from a related entity or sold to a related entity. Since Flick Sales Inc. and Flick United Sates are related and since Flick United States is selling items to a related entity so taxation applies under subpart F income. In addition, Flick Sales Inc. is selling items (lighters) that are manufactured and then sold outside of the country (Country X) where Flick Sales Inc. is incorporated. Given this situation, subpart F income is again seen to occur under Section 957(a). 3. If you determined that Flick Sales, Inc. has subpart F income, how does this impact its shareholder, Flick Parent, Inc.? Facts Flick Sales Inc. is owned wholly by Flick. The new corporation has been set up in Country X with a tax rate of 25%. All stock of lighters is bought from Flick while it is sold to Country Y, where the tax rate is 25% as well. For the 2010 tax year, the total earnings from sales of Flick Sales Inc. were $5 million. Interpretation Given that Flick Sales Inc. is a CFC under the umbrella of Flick Parent Inc., it is apparent that the income of Flick Sales Inc. is subject to subpart F income regulations. Since Flick Sales Inc. is wholly owned subsidiary, its parent company Flick Parent Inc. is wholly responsible for paying taxes on any income generated by Flick Sales Inc. Such taxation occurs not merely in Country X but also inside the United States where subpart F income is subject to taxation unlike dividend based income of CFCs. In the current circumstances, Flick Parent Inc. will have to pay applicable United States taxes as well as applicable Country X taxes for Flicks Sales Inc. 4. If you concluded that Flick Sales, Inc. had subpart F income, could the parent receive an indirect credit for taxes paid by Flick Sales, Inc.? What statute(s) did you rely on for your conclusion? Facts Flick Sales Inc. is owned wholly by Flick. The new corporation has been set up in Country X with a tax rate of 25%. All stock of lighters is bought from Flick while it is sold to Country Y, where the tax rate is 25% as well. For the 2010 tax year, the total earnings from sales of Flick Sales Inc. were $5 million. Interpretation Subpart F income such as in the current case can be subject to discounted taxation rates through direct tax credits and / or indirect tax credits. Indirect credit for taxes may only occur if the taxes are imposed on the foreign corporation which in the current case happens to be Flick Sales Inc. Moreover, indirect credit for taxes can only be claimed in the United States when foreign income taxes are applied on dividends paid by a company that is owned at least 10% or more by United States persons. However, in the current case, Flick Sales Inc. has an income from sales of lighters and not from dividends so indirect tax credits do not apply. Hence, Flick Parent Inc. cannot claim indirect tax credits for Flick Sales Inc. 5. In you concluded that Flick Sales, Inc. had subpart F income, how does this impact the basis of the parent in the stock of Flick Sales, Inc.? What statute(s) did you rely on for your conclusion? Facts Flick Sales Inc. is owned wholly by Flick. The new corporation has been set up in Country X with a tax rate of 25%. All stock of lighters is bought from Flick while it is sold to Country Y, where the tax rate is 25% as well. For the 2010 tax year, the total earnings from sales of Flick Sales Inc. were $5 million. Interpretation Given that Flick Parent Inc. is going to be charged for taxes twice in the current circumstances, it is advisable that the current arrangements be revised to reduce the applicable taxes. Flick Parent Inc. is being taxed in the United States and in Country X too since direct tax credits and indirect tax credits do not apply to the current situation. Hence, it would make sense if Flick Parent Inc. would reduce its ownership in Flick Sales Inc. so that it could avoid the taxation it faces inside the United States. Read More

 

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