What Permanent Establishment Is - Coursework Example

? Part One – Jurisdiction to Tax Please read the following and answer the questions that follow. (15% of the total exam) A foreign corporation, Corporation A, decided to expand its operations from its incorporation jurisdiction in Country X to the US. In order to facilitate sales made to the US, Corporation A has rented space in a licensed public warehouse in Massachusetts where it stores some of its inventory. Other than this licensed public warehouse and $2,000 of inventory held within it, Corporation A has no physical presence in any state in the US. In other words, it has no other property or employees in the US. Please read the applicable treaty provision and Massachusetts law and answer the questions that follow. Treaty with Country X PERMANENT ESTABLISHMENT 1. For the purposes of this Convention, the term "permanent establishment" means a fixed place of business through which the business of an enterprise is wholly or partly carried on. 2. The term "permanent establishment" includes especially: a) a place of management; b) a branch; c) an office; d) a factory; e) a workshop; and f) a mine, an oil or gas well, a quarry, or any other place of extraction of natural resources. 3. A building site or construction or installation project, or an installation or drilling rig or ship used for the exploration of natural resources, constitutes a permanent establishment only if it lasts, or the exploration activity continues for more than twelve months. 4. Notwithstanding the preceding provisions of this Article, the term "permanent establishment" shall be deemed not to include: a) the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise; b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery; c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise; d) the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise, or of collecting information, for the enterprise; e) the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character; f) the maintenance of a fixed place of business solely for any combination of the activities mentioned in subparagraphs a) through e), provided that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary character. MASSACHUSETTS LAW Except as otherwise provided in this section, every business corporation, organized under the laws of the commonwealth, or exercising its charter or other means of legal authority, or qualified to do business or actually doing business in the commonwealth, or owning or using any part or all of its capital, plant or any other property in the commonwealth, shall pay an income measure tax. A business corporation shall not be subject to the income measure of tax under if it is engaged in the business of selling tangible personal property and taxation of that business corporation under this chapter is precluded by the constitution or laws of the United States, or would be so precluded except for the fact that the business corporation stored tangible personal property in a licensed public storage warehouse, but no portion of any warehouse which is owned or leased by a consignor or consignee of the tangible personal property shall be considered a licensed public warehouse. 1. Does the treaty provision protect Corporation A from taxation by the US? Why or why not? The treaty provision protects Corporation A from taxation in the US on multiple fronts. Under regular Massachusetts law, any business that has a de minimis physical presence in the form of any assets, employees, contracted obligations, rented property etc. in Massachusetts is subject to taxation. This clause applies equally well to any foreign corporations doing business in Massachusetts under M.G.L. c. 62, s. 39. However, given the provisions of the treaty it is widely clear that rented places for business are considered exclusive from “permanent establishments”. On another note, inventory stored in a rented warehouse has also been made exclusive of tax by providing that such stock is not taxable no matter what the use of such stock is. Lastly, the treaty has ensured that only if “a consignor or consignee of the tangible property” stored in a “licensed public warehouse” is discovered, only then they are subject to tax. In the current case, this ambiguity will allow Corporation A to evade taxes in the US under Massachusetts laws with ease. 2. After reading Quill, do you believe Corporation A has a sufficient connection with the US for nexus purposes under the Commerce Clause of the US Constitution? Why or why not? In the current situation, after looking through Quill, it is clear that Corporation A has sufficient connection with the US for nexus purposes under the Commerce Clause of the US Constitution. Under Quill v. North Dakota, it was determined that the presence of floppy disk footnotes was not enough as larger and more determined presence was required. In the current case, Corporation A has a rented storage space as well as stock placed in such a space which provides for physical presence tests. Also, under the Burger King area in the due process test, complete physical presence is not required to be responsible for tax purposes. The commerce clause still requires that there should be more than a de minimis presence in the US to be responsible for tax and Corporation A satisfies those conditions. 3. Based solely on the Massachusetts law above, would Massachusetts impose its income measure of tax on Corporation A? Why or why not? Based solely on Massachusetts law, income measure of tax would be imposed on Corporation A since it satisfies all of the conditions for taxation measure. As provided by 830 CMR 63.39.1 (8)(b)-(d), any foreign corporation that is using Massachusetts as its base is subject to excise taxes under M.G.L. c. 62, s. 39. Part Two – Division of Income among Jurisdictions Please read the following and answer the questions that follow. (25% of the total exam) A foreign corporation, Corporation A, has a US trade or business due to its activities conducted in the US. Corporation A purchases inventory from wholesalers outside the US and resells the inventory to customers located in State X of the US. Title to the property transfers to its State X customers when it reaches its final destination in State X. Corporation A also provides services for its customers for a fee. Please address the following federal income tax questions in a manner consistent with the Internal Revenue Code and the Treasury Regulations: 1. From a US tax perspective, how would the Internal Revenue Code determine whether the inventory sales constitute US source income? The Internal Revenue Code would need to determine the source of the goods and their final destination in the US to see if tax applies. In the current case, Corporation A is procuring goods from another country and then reselling them in State X in the US, which effectively makes them susceptible to taxation. Broadly speaking, under Section 864(c) any foreign person or business undertaking transactions in the US is considered to be connected to the US. In order to determine an effective connection for a business operating in the US, two tests are performed namely: Asset use test; Activities test. Under the asset use test, any income that is gained or lost through transactions performed through items held for business are liable to taxation. Moreover, under the activities test, any activities used for business to derive an income, gain or loss are liable to taxation. 2. From a US tax perspective, how would the Internal Revenue Code determine whether the services should constitute US source income? The Internal Revenue Code would rely on the Force of Attraction test in order to determine if the services business would constitute US income. Under 864(c)(2), it has been made clear that any other activities performed by any business operating in the US, such as services, are subject to tax given the presence of the business in the US in a business capacity. The Force of Attraction Rule makes it abundantly clear that any connection to any other business in the US would make the services rendered liable to tax. Since Corporation A is dealing with business in the form of sold inventory, so any services performed by it would also be considered liable to taxation in the US since it would be US income. 3. How would your answer in question 1 change if Corporation A manufactured the inventory outside the US and sold the inventory in the US? If Corporation A manufactured its goods outside the US and sold the inventory in the US, it would still be liable to tax. The manufacturing process is taxable when done in the US but it would not be taxable when done in another country. However, the sale of goods by Corporation A in the US would constitute business activities that would be tested under the asset use test and the activities test. The presence of Corporation A in the US would render it liable to taxation due to business transaction although the amount of tax would be reduced since the manufacturing took place outside the US. Please address the following multistate income tax questions in a manner consistent with the general multistate corporate income tax rules we discussed in class: 1. Under the general rules we discussed in class, how do most states determine whether a sale is sourced to their state for purposes of computing the sales factor? In other words, how do they assign sales to the numerator of the sales factor? Most states use a combination of different factors out of the total number of factors being utilized to determine if the sale is sourced to their state. The Ultimate Destination Rule, the Dock Sales and Intangibles are used for goods that are sold and bought. On the other hand, any services that are sold are determined in the numerator by the cost of performance and the state in which the market actually lies. In addition, the Throwback Rule is also applied along with the check that the goods or services are not sold to the US government. In case that the goods or services are sold to the US government, the originating state is referred to for tax purposes. 2. Under the general rules we discussed in class, what are the two main methodologies used by states to determine whether receipts from services should be sourced to their state for purposes of computing the sales factor? You only need to provide the names of the two methodologies. The main methodologies used by states to determine whether receipts from services should be sourced to their state for the computation of the sales factor are: Cost of performance; Market state. 1. 2. 3. 4. Part Three – US and State Taxation Systems Please read the following and answer the questions that follow. (20% of the total exam) 1. In class, we discussed the differences in taxing systems around the world. More specifically, we discussed the worldwide taxation system used by the US and the territorial taxing systems often (but not always) used in other parts of the world. Please briefly describe the mechanism used by each to mitigate double taxation on taxpayers. Your answer should briefly discuss tax credits and sourcing rules. One or two short paragraphs should be sufficient here. Please use your own words and do not copy paragraphs from reference books or textbooks here. In order to avoid double taxation from affecting people and businesses operating in more than one country, tax treaties are drafted out between the interacting nations. The tax treaties executed between the central governments of both involved nations ensures that the rights and duties of the individuals and businesses operating within both jurisdictions are laid out clearly. The income derived by any such individuals and businesses are classified and relevant taxes are then applied accordingly. In the case of the US, there is the US Model Treaty that has been designed to cope with such issues. When a tax treaty is executed between two nations, the nations decide on what thresholds to settle for taxing the incomes. Additionally, methods are laid out to determine where the source of the income lies. It is typical to see tax treaties that allow taxation to occur within the jurisdiction where the income is generated or sourced from. In addition, people and businesses operating between nations may also be given tax credits in order to lower their overall taxation burden. 2. Please compare your answer above to how states handle the division of income among corporate taxpayers. In contrast to how nations handle taxes in multiple jurisdictions, states within the US tend to divide taxed from corporate taxpayers through the use of multiple criteria. The basic contention in dividing sales for taxation between states tends to remain the same – the source where the income has been generated has the authority for taxation. For example, if a good is sold in State X by a corporation incorporated in State Y, the taxation authority resides with State X. Tax credits are also present though not uniformly between one state to another. 5. 6. 7. 8. Part Four – Residency 9. Please read the following fact pattern and answer the question that follows. (20% of the total exam) Since 1986, the Flicks owned a home at 451 Flick Road in Milford, Connecticut. At the time of their departure for France in 1996, the Flicks lived in their Milford residence with their daughter Carolyn, a son Paul of high school age and three older children attending college outside of Connecticut. Robert Flick (Flick) was employed continuously by Flick, Inc. since October 1, 1980. He presently serves as president of that company. In January 1996, Robert Flick was offered a position in Paris, France, to serve as the president of Flick Europe, a management unit of Flick, Inc. headquartered in Paris. Flick immediately accepted the position and went to France that same month. Carol Flick and Carolyn, then ten years old, moved to France in April of 1996. At that time, the Flicks' son, Paul, was a junior at Milford high school and remained in Milford for the 1996-1997 school year, living at the home of family friends. Paul graduated high school in 1997. A “Letter of Understanding” was entered into between Robert Flick and Flick, Inc., which set forth the terms and conditions of Flick's employment in France. This letter also served the purpose of allowing Flick to obtain a work visa from the France authority. The letter of understanding provided that the period of Robert Flick's expatriate assignment was “expected” to be three to five years. Senior executives with Flick, such as Robert Flick, are often transferred from one location to another, whether within the United States, or to locations in Europe, Asia or the Pacific. Flick did not make commitments to their senior officers with respect to how long each assignment would be. Rather, the future needs of the company dictated the duration and location of the assignment. The duration of the assignments was contingent upon the needs of the Company, not the needs of the individual employee. When the Flicks moved to France, they retained ownership of their house in Milford. The house was leased to a married couple from September 1, 1996 to July, 31, 1998. A second lease to another couple was entered into on August 1, 1998 for a duration of two years, but the lease was terminated in early 2000 by the tenants. The house was next leased to a couple on a short term basis from February 1, 2000 to the end of June 2000. Beginning in September of 2000, the Flicks made substantial renovations to the house at a cost of over $700,000. While residents of Milford, prior to the move to France, the Flicks were congregants of St. Joseph’s Church in Milford. Upon their move to France, they registered as members of Our Lady of Hope in Paris. As members of the Paris church, the Flicks fully participated in church life and activities. While in France, the Flicks continued to fulfill their pledge obligations previously made to St. Joseph’s. Upon their return to the states from France, the Flicks joined St. John’s in Armonk, New York, where they resided for a short period of time, and later rejoined St. Joseph’s. The Flicks' daughter, Carolyn, moved to France with her parents and enrolled in the International School of Paris from April 26, 1996 to June 21, 2000. The Flicks also opened a bank account in France to attend to their banking needs Carol Flick retained her Milford bank account so that she could write checks to her son Paul, who was attending high school in Milford. The Flicks also surrendered their Connecticut driver's licenses in favor of obtaining French licenses. The Flicks filed a 1996 French income tax return that was prepared by Ernst & Young, reflecting the Flicks' French address. Robert Flick received special tax treatment under French law that offered lower taxes to employees of foreign-owned corporations who are not citizens of France, but are residents of France. For this reason, the Flicks filed their French tax returns as nonresidents under a special tax regime. While a resident of Milford, Robert Flick was a member of the Milford Country Club in Milford, Connecticut. Milford is an exclusive country club where one must wait some seven years to gain golfing privileges. Rather than forfeit his membership at Milford, upon moving to France, Robert Flick chose to change his membership to an inactive non-resident status so that it could be reinstated in the future. John Doe, Flick’s tax director has contacted you. Connecticut’s personal income tax auditors have determined that the Flicks were domiciled in Connecticut for the tax periods 1996 and 1997. John Doe would like you to assess Mr. Flick’s case (how likely will he be able to defeat the state’s claim that he should be taxed as a resident because he was domiciled in the state of Connecticut for the tax periods 1996 and 1997). In doing so, John Doe would like you to list in two separate columns the good facts and the bad facts from the facts he has given you above. Facts Indicating Connecticut Resident Facts Indicating Connecticut Nonresident Robert Flick and his wife Carol Flick and their daughter Carolyn were domiciled in the state even if the 183 days test is not met. Robert Flick and his wife Carol Flick and their daughter Carolyn do not fulfill the 183 days test. The house at Milford indicates a permanent place of abode. Dwelling places leased for a period of more than one year to an unrelated third party voids the permanent place of abode. Robert Flick’s son Paul was still in Connecticut for more than a year and so was domiciled as a student. Robert Flick and his wife gave up their driving licenses early on indicating their cancellation of domicile. Robert Flick’s employment in France was temporary in nature so the Connecticut domicile should be upheld. The family was present was a low percentage of time in the entire year at Connecticut. Robert Flick’s membership at the exclusive country club and its later dormant status provides for his domicile in the state of Connecticut. The family members were present close to each other in France and not in Connecticut. Carol Flick had a bank account in Milford that signifies a domiciled relationship. The relative time spent in Connecticut after the transfer was next to nothing. The place of worship, St. Joseph’s remained unchanged signaling a strong connection to Connecticut. Robert Flick was moved in official capacity to France and hence his income derived from sources in France. Paul’s school remained in Connecticut for the entire year indicating domiciled relationships. No change of domicile was ever applied by any member of the family. The “near and dear” items / property remained in Connecticut given the large investment of the renovation of the house at Milford. Robert Flick continued to work for a US corporation operating abroad. 10. 11. 12. 13. Part Five – Miscellaneous Short Answers 14. Please read the following and answer the questions that follow. (20% of the total exam) 1. Wrigley v. Wisconsin Department of Revenue discussed which federal law? The application of different state franchise taxes to any businesses operating out of the state under the Interstate Income Act of 1959. 2. When taxpayers find that they have inadvertently omitted filing tax returns in various states, what process can they undertake to mitigate the penalties and/or interest imposed by the states? The taxpayers who have inadvertently omitted filing tax returns in various states need to contact the IRS and submit any discrepancies as soon as possible voluntarily to circumvent the possibility of penalties and interest imposed. 3. What rule requires that taxpayers include in the numerator of their sales factor sales made to states where they are protected from taxation? The Throwback Rule 4. Many states average 3 different fractions/factors to determine their apportioned share of income. What are those 3 fractions/factors? In state property; In state payroll; In state sales. 5. A profitable corporation (with sales evenly spread across the US) plans to relocate substantial property and people to a new state. Should it move to a state that averages the three fractions or move to a state that determines apportioned income using only the sales factor? It would be profitable to move to a state that utilizes the in state sales factor alone since it would circumvent the need to tax both in state property as well as in state payroll for the relocating corporation. 6. What is the term used to describe an agreement to share costs between related parties with respect to intangibles? Transfer pricing 7. What is the term used in various treaties that describes the minimum connection necessary for a country to impose tax on a foreign business? Fixed or determinable annual or periodic (FDAP) gains 8. For purposes of determining the source of their income, the Internal Revenue Code requires taxpayers engaged in a mixed service transaction (production and sale of goods for example) to treat 50% of their income as associated with the production of the goods and 50% of their income as associated with the sale of goods. However, taxpayers may elect to use a different split of their income if they can establish that they have established a particular price. What is the price called? Due process price 9. Name the transfer pricing method that compares the amount charged in a controlled transaction with the amount charged in a comparable uncontrolled transaction? Comparable Uncontrolled Price 10. In the comparable profits method, what do we call the controlled party that has the least complex, readily available and accurate financial data from which to draw a comparison? Tested party Read More