Cross-Jurisdictional Quiz 1 (Ch. 2-3)
Why is the study of international taxation important for CPAs?
-multinational corporations could be our clients -may have clients that live abroad/work abroad -trade or business that sells things abroad -can invest abroad -on the CPA exam
substantial presence test
-non-US citizen needs to be in US for at least 183 days -MUST be present at least 31 days in the current year FORMULA: current year # of days + (1/3 * prior year days present) + (1/6 * second prior year days present) If equals or exceeds 183 days, person is considered a resident alien
Who are foreign persons?
1. Nonresident aliens (NRA) 2. Foreign corporations 3. Foreign partnerships
Who are considered US persons?
1. US citizens 2. Resident aliens 3. US corporations 4. US partnerships
the foreign tax credit equals the lesser of
1. creditable taxes paid or accrued to all foreign countries or US possessions OR 2. the foreign tax credit limitation
Cupcake Bakery is located in Detroit. Cupcake sells some of their baked goods across the border in Canada. Each morning, one of their Canadian employees (and Canadian citizens), drives to Detroit to pick up baked goods to sell in Canada. During 2019, Robert Sweets drove 120 days from Canada to Detroit and back to Canada, spending a total of 240 hours in the US. Sweets earned the US dollar equivalent of $50,000, working 1920 hours in 2019. What if Sweets limits his trips to 90 days during 2019 and limits his hours to 180 spent in the US?
180/1920 x $50,000 = $4,688 > $3000; fails exception
Credit/residence-based jurisdiction
A country may claim that all income earned by a citizen or resident or company incorporated in the country is subject to taxation in the country because of a citizen's/company's relationship with the country. The country allows a credit for taxes paid to another country. Thus, this taxes on WORLDWIDE income. (pre-2018, corporations taxed like this)
Distinguish between an outbound transaction and an inbound transaction from a U.S. tax perspective.
An outbound transaction occurs when a U.S. person engages in a transaction outside the United States or one that involves a non-U.S. person. An inbound transaction occurs when a non-U.S. person engages in a transaction within the United States or one that involves a U.S. person.
Territorial/source-based jurisdiction
Bases tax jurisdiction on a territorial connection; this means that a country looks to the connection that a person or income may have to its country. In essence, they tax transactions that occur WITHIN the country ONLY. (post-2017, corporations were taxed like this)
Assume Green does not tax its residents on worldwide income, but rather only on income earned within Green's border. Assume Blue taxes transactions occurring within its borders as well. Where will Elmer be taxed on the sale?
Blue, because that's where the sale occurs/title passes.
How can a country justify a credit-based/residence-based jurisdiction?
Citizenship; a person is afforded rights from their home country whether or not they are in that home country.
How does the US tax foreign activities of foreign persons?
Effectively connected income: trade or business income, which is taxed on net income at graduated tax rates US-source investment income: taxed on gross amounts at flat withholding rate of 30%
How does the US mitigate double taxation of US persons?
For dividends received by US corporations from foreign corporations: participation exemption All other types of income: generally eligible for foreign tax credit Also, foreign-earned income exclusion
Will a country tax income with which it has no connection?
Generally, no.
Elmer Co. is an auto manufacturer located in country Green. George purchases Elmer's newest car, the Elmer Pinto. George, a resident of country Blue, has the Pinto delivered to him at work in country Blue. Which country, Green or Blue, will tax Elmer on the sale of the Pinto?
It depends on how they determine nexus.
How do tax treaties mitigate double taxation?
It is an agreement that the host country does not tax taxpayers from the home country and vice versa.
Foreign-earned income exclusion
Provided that income is earned (i.e not an investment) $103,900 For people who have established a tax home in a foreign country or present in foreign country for 330 days in a 12 month period
How does an alien become a US resident?
Section 7701(b): bright line test which includes: -green card test (lawful permanent residence) -substantial presence test
What is the study of international taxation?
Study of coordinating the tax authority of sovereign countries
Cupcake Bakery is located in Detroit. Cupcake sells some of their baked goods across the border in Canada. Each morning, one of their Canadian employees (and Canadian citizens), drives to Detroit to pick up baked goods to sell in Canada. During 2019, Robert Sweets drove 120 days from Canada to Detroit and back to Canada, spending a total of 240 hours in the US. Sweets earned the US dollar equivalent of $50,000, working 1920 hours in 2019. What if you discover a treaty between Canada and the US whereby NRAs are not taxed if they are in the US for no more than 183 days and the $3000 limitation for income is removed?
Sweets gets the exception so his income is not taxable in the US
What is nexus?
The criteria that jurisdictions use to assert the right to tax a person or transaction.
Where can we find information regarding cross-jurisdictional taxation in the code?
Title 26 of US Code: Internal Revenue Code Subtitle A Income Taxes Subchapter N: Tax based on income from sources within or without the United States sections 861-999
What are the two categories of income that can be taxed by the United States when earned by a nonresident? How does the United States tax each category of income?
U.S. source income earned by a nonresident is classified as either effectively connected income (ECI) or fixed and determinable, annual or periodic income (FDAP). Income that is effectively connected with a U.S. trade or business is subject to net taxation (that is, gross income minus deductions) at the U.S. graduated tax rates. FDAP income, which is generally passive income such as dividends, interest, rents, or royalties, is subject to a withholding tax regime applied to gross income.
How does the US tax foreign activities of US persons?
US citizens/corporations/persons: taxed on worldwide income Foreign citizens/corporations: taxed only on income within the US
How does a residence-based approach to taxing worldwide income differ from a source-based approach to taxing the same income?
Under a residence-based approach, a country taxes the worldwide income of the person earning the income. Under a source-based approach, a country taxes only the income earned within its boundaries.
How do countries combat double taxation?
Unilateral legislation (specific to the US): foreign tax credit, foreign income exclusion, and the participation exemption Bilaterial legislation: tax treaties
Jade, a foreign citizen, was present in the US for 90 days in 2010, 180 days in 2011, and 110 days in 2012. Is Jade considered a resident for 2012?
Yes. 110 + (1/3 * 180) + (1/6 * 90) = 110 + 60 + 15 = 185 185 > 183
Camille, a citizen and resident of Country A, received a $1,000 dividend from a corporation organized in Country B. Which statement best describes the taxation of this income under the two different approaches to taxing foreign income? a.Country B will not tax this income under a residence-based jurisdiction approach but will tax this income under a source-based jurisdiction approach. b.Country B will tax this income under a residence-based jurisdiction approach but will not tax this income under a source-based jurisdiction approach. c.Country B will tax this income under both a residence-based jurisdiction approach and a source-based jurisdiction approach. d.Country B will not tax this income under either a residence-based jurisdiction approach or a source-based jurisdiction approach.
a.Country B will not tax this income under a residence-based jurisdiction approach but will tax this income under a source-based jurisdiction approach.
foreign tax credit
allows US taxpayers to reduce their US tax liability by their foreign-source income
how is income sourced outside the US?
as foreign-sourced income
method of sourcing: income from the sale of inventory produced by the taxpayer
based on location of production assets
method of sourcing: dividends
based on residence of corporation paying the dividends exception: foreign corporation earns 25% or more of US effectively connected income for 3 prior tax years; this percentage is US source income
method of sourcing: interest income
based on residence of debtor or borrower NOTE: foreign branch of a US bank is foreign source
method of sourcing: gain on the sale of patents and other intangible property
based on the residence of the seller
method of sourcing: gain on the sale of personal property
based on the residence of the seller NOTE: includes corporate stock; based on the residence of the owner of the stock
method of sourcing: personal services income
based on where services are performed NOTE: commercial traveler exception
method of sourcing: gain on the sale of real property
based on where the property is located
method of sourcing: rentals and royalties
based on where the property is located
US citizen
could be born in the US, born to a parent who is a US citizen, or nationalized (14th amendment states this)
home country
country a taxpayer is a citizen of
method of sourcing: gain on the sale of depreciable property
depreciation recapture: follows prior depreciation sourcing remaining gain: where title passes
nonresident aliens
do not live in the US and are not US citizens (or do not meet requirements of resident alien)
What is the central problem of international taxation?
double-taxation
Anderson, Inc. (a US company) issues a license to Lemco (a Dutch company) for use of computer software in France. What is the source of the royalty income?
foreign-source
Oliver, a resident of Jamaica, sells 250 shares of Great Cola (a US company), for $35,000. Oliver purchased the stock for $20,000. What is the source of the gain?
foreign-source
Quill, Inc. (a US company) purchases staplers from a manufacturer in Mexico. Quill sells the staplers to SteveCo. (a Brazil company) with title passing in Argentina. Describe the type of income generated on this sale.
foreign-source
Cupcake Bakery invests $50,000 in 5-year bonds issued by the Canadian government with an interest rate of 3%. Cupcake Bakery received C$1,500 interest from the bonds. What is the source of this interest income?
foreign-sourced
John, a US resident, earns US$250 of interest from the Paris brach of ABC bank (a US bank). What is the source of John's income?
foreign-sourced
How a non-US person with foreign-source income is taxed
generally taxed only in non-US jurisdiction
US taxpayers want ______ foreign source income and _____ foreign source deductions
high; low
Resident alien
lives in US but is not a US citizen
non US taxpayers want ____ US source income and ___ US deductions
low; high
green card test
non-US citizen holds a green card (permanent resident visa)
commercial traveler exception
personal service income earned by nonresidents in the US is not treated as US source if the following criteria is met: 1. the individual was present in the US for 90 days or less during the current taxable year 2. compensation for the services does not exceed $3000; and 3. services are performed for an NRA, foreign corporation, or foreign partnership or for the foreign office of a domestic corporation tax treaties can be put in place to extend 1. to 183 days and remove 2.
How a non-US person with US-source income is taxed
potentially taxed in US (inbound)
inbound income
refers to the US taxation of US-source income earned by foreign taxpayers
outbound income
refers to the US taxation of foreign-source income earned by US taxpayers
Carmack, Inc. (a US company) purchased a tractor three years ago for $10,000. Carmack took $3,000 of depreciation for US tax purposes. Assume Carmack sells the tractor for $12,000 to Maple, Inc. (a Canada company) with title passing in Canada. What is the source of the gain?
sold for $12,000 $7000 basis = $5000 gain $3000 of gain depreciation recapture -> US source $2000 remaining gain -> foreign source
method of sourcing: income from the sale of inventory PURCHASED for resale
sourced on where sale occurs/title passes
how is income sourced inside the US?
sourcing rules found in sections 861-865; tells us our sources within the US
How US person with US-source income is taxed
taxed in US
How US person with foreign-source income is taxed
taxed in both US and non-US jurisdiction (outbound)
foreign tax credit limitation calculation
total US tax liability * (foreign source taxable income / total worldwide taxable income)
Cupcake Bakery is located in Detroit. Cupcake sells some of their baked goods across the border in Canada. Each morning, one of their Canadian employees (and Canadian citizens), drives to Detroit to pick up baked goods to sell in Canada. During 2019, Robert Sweets drove 120 days from Canada to Detroit and back to Canada, spending a total of 240 hours in the US. Sweets earned the US dollar equivalent of $50,000, working 1920 hours in 2019. How much US source income does Sweets have in 2019?
total income: $50,000 -> 1920 hours 240 hours in US $50,000 x (240/1920) = *$6250*
host country
where taxpayer is living abroad
Cupcake Bakery, a US manufacturer, makes cupcakes at its US manufacturing facility. Total cupcake sales for the year are $750,000. ($250,000 of cupcakes to Canadian supermarkets (title passing in Canada) and $500,000 of cupcakes to various Canadian vendors (title passing in the US)). What is Cupcake's foreign source income?
$0; based on location of production
Ann (a US citizen) receives $300 in dividends from Orange corporation, a foreign corporation. For the past three years, Orange's effectively connected US income has been 92%. Ann also receives $600 from Brown corporation, a domestic corporation. For the past three years, Brown's effectively connected US income has been 13%. What is Ann's US source income?
$876 all of $600 + ($300 x .92) = $276 = $876