Cross Exam 1

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What taxpayers are eligible for the participation exemption?

US corporations ONLY. Must own at least 10% of voting/value stock in the foreign corporation.

Resident Alien

Lives in US but not a US citizen must meet one of 2 tests: -green card test -substantial presence test

foreign branch: US taxation

income taxed immediately, BUT allows for loss recognition by the US corporation

form 1116

individuals use to calculate foreign tax credit

What are some advantages to hybrid entities?

-gives us flow-through of income, plus liability insolation for parent -can claim direct foreign tax credit -allows US parent to avoid subpart F income

USAco has its only business operations in foreign country F. In Year 1, the foreign operations earn $100,000. USAco did not repatriate any of the earnings. How much income will USAco report in Year 1 if the foreign operations are operated as a subsidiary?

USAco has its only business operations in foreign country F. In Year 2, the foreign operations lose $100,000. USAco did not repatriate any of the earnings. How much income will USAco report in Year 2 if the foreign operations are operated as a subsidiary?

Cupcake Bakery, a US corporation, makes cupcakes at its US manufacturing facility near Burlington, VT. The following information relates to Cupcake's 2019 activity. Determine whether the income is foreign-source or US source. All amounts are US dollars. 1. Cupcake invests $50,000 in 5-year bonds issued by the Canadian government with an interest rate of 3%. During 2019, Cupcake Bakery received $1,500 interest from the bonds.

$1,500 foreign source

Diaz, Inc. (a US corporation) owns 45% of Pimento Corp. (a CFC). Pimento's pretax net income for the year is $1,500,000 and foreign taxes paid are $225,000. Pimento's adjusted basis of depreciable assets at the end of each quarter is: $1,200,000 (1Q), $1,345,000 (2Q), $1,500,000 (3Q), $1,300,000 (4Q). What is Diaz, Inc.'s GILTI inclusion and deduction? Calculate the foreign tax credit.

$1,500,000 -$225,000 = $1,275,000 CFC tested income -(1,200,000 + 1,345,000 + 1,500,000 + 1,300,000) / 4 = $1,336,250 x 10% = $133,625 =$1,141,375 x 45% ownership = $513,619 GILTI inclusion + [(513,619/1,275,000) x 225,000] = $90,639 Sec. 78 gross up = $604,258 total inclusion x 50% = $302,129 GILTI deduction $604,258 - $302,129 = $302,129 GILTI net taxable income FTC = (GILTI taxable income / WW income) x US tax US tax = $302,129 x 21% = $63,447 FTC = (302,129/302,129) x $63,447 FTC = $63,447 $90,639 x 80% = $72,511 FTC eligible creditable taxes take credit of lesser amount US tax $63,447 ($63,447) credit = $0 tax excess credit is lost; cannot carry forward or carry back

$100,000

Robert Sweets, a US citizen, lives in Burlington, VT, which is close to the Canadian border and a short two-hour drive to Montreal. Robert works for Cupcake Bakery in Burlington and drives to Montreal each week to check in with vendors and customers. The following information relates to Robert's 2019 activity. Determine whether the income is foreign-source or US source. All amounts are US dollars. 3. Robert sells 250 shares of Suncor Energy (a Canadian corporation) for $35,000. Robert purchased the stock for $20,000.

$15,000 US source

$250 + $300 + $600 + $1500 + 50,000 = $66,150 taxed on worldwide income so source doesn't matter

$250 foreign-source

Charlotte, Inc., a domestic corporation with operations in England, has total taxable income for the tax year of $120,000, consisting of $100,000 US-source income and $20,000 from England. Taxes paid to England totaled $9,500. Charlotte's US tax before FTC is $42,000. What is Charlotte's US tax?

$42,000 * ($20,000/$120,000) = $7,000 Credit is lesser of $7,000 or $9,500, so $7,000 $42,000 - $7,000 = $35,000 US tax

Cupcake Bakery, a US corporation, makes cupcakes at its US manufacturing facility near Burlington, VT. The following information relates to Cupcake's 2019 activity. Determine whether the income is foreign-source or US source. All amounts are US dollars. 5. Cupcake purchased an industrial oven three years ago for $700,000 and took $300,000 of depreciation for US tax purposes. Cupcake sold the oven in 2019 for $500,000 to Maple, Inc. (a Canada company) with title passing in Canada.

$500,000 sales price - $400,000 adj basis = $100,000 depreciation recapture: US source Adjusted basis calculation: $700,000 - $300,000 = $400,000

($100,000) loss

BEAT calculation

(BEAT rate X modified taxable income) less the regular US corporate income tax if regular US tax exceeds BEAT amount, only pay regular US tax

4 tax advantages of foreign subsidiaries

-Can control the timing of our income recognition -eligible for participation exemption -Possible local tax benefits since they are now citizen of that foreign country -Easier to justify deductible payments paid to US parent to local authorities

4 tax advantages of foreign branches

-Loss recognition: can deduct our foreign losses immediately -tax-free transfer of assets -As income is earned by branch and repatriated to US, not subject to at-source withholding -Individuals that have a branch are eligible for direct credit under sec. 901

Foreign-earned income exclusion

-Must be foreign source income that is *earned* (NOT investment income) -$107,600 To qualify, establish tax home in foreign country or present in foreign country for 330 days in 12 month period

§903 "in lieu of" credit

-at source withholding; withholding occurs at the source of the income -calculated on gross income

special sourcing rule: How is interest expense apportioned to income?

-based on income that all assets produce -will use the average tax book value for *all assets* ((Jan. 1 balance + Dec. 31 balance) / 2)

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

What are some disadvantages to hybrid entities?

-profits subject to immediate taxation -treaty benefits are not applicable

Why is foreign taxation an important issue for US exporters?

-tariffs/additional tax -Administrative cost to comply -foreign tax credit limitation can increase our overall tax rate; higher net tax if foreign tax rate exceeds US tax rate

related person

1) A corporation that controls or is controlled by the CFC OR 2) A corporation that is controlled by the same person or persons who control the CFC.

A US shareholder's ownership of a CFC does not automatically cause current inclusion of ALL CFC income. Subpart F income refers to the following types of income which are included in the current gross income of US shareholders:

1) Insurance income § 953 2) Foreign base company income § 954 3) International boycott factor income § 999 4) Illegal bribes 5) Income derived from a § 901(j) foreign "black-listed" country

Modified taxable income is taxable income without deductions for:

1) Payments to related foreign parties (e.g., rents, royalties, interest, most service fees) that are not subject to withholding, and 2) Depreciation on property purchased from related parties Payments for cost of goods sold, deductions for GILTI and FDII and the DRD are not adjusted for.

Mechanisms to Prevent Double Taxation: Distributions of previously-taxed income Can exclude from income distributions of a CFC's E&P that were previously taxed by reason of:

1) any increase in earnings invested in US property, 2) Subpart F income, 3) Other E&P (this is the only portion which represents a dividend to the shareholder.)

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

The foreign tax credit is available only if a tax:

1) was paid to a foreign country and 2) the predominant character of the tax is that of an income tax in the US sense. * *a tax that does not meet the second requirement may be creditable as a Sec. 903 "in lieu of" tax

Income that meets the following two tests is subject to withholding:

1)The income is fixed, determinable, annual or periodic, and 2) The income is derived from sources within the US

Della, Inc., a domestic corporation with a manufacturing facility in Mexico, has the following items in 2020: Transaction Total taxable income for the tax year of $750,000 1. $350,000 in taxable income from sales attributable to foreign sources with $105,000 in taxes paid to foreign jurisdictions 2. $8,500 payment* received for dividends from Nestle S.A. (a Swiss corporation) *Nestle withheld $1,500 in at-source withholding what is the Code section that allows for a FTC for each transaction?

1. 901 2. 903

James Brown, Inc. (JBI), a domestic corporation with operations in Canada, has the following items in 2020: Transaction Total taxable income for the tax year of $550,000 1. $150,000 branch net income in Canada with taxes paid to Canada of $60,000 2. $4,250 payment* received for interest from Royal Bank of Canada (RBC) *RBC withheld $750 in at-source withholding what is the Code section that allows for a FTC for each transaction?

1. 901 2. 903

5 FDAP withholding exemptions

1. Effectively Connected Income (ECI) 2. Income from sale of personal property 3. Portfolio interest on obligations issued by a US person 4. Interest income earned by foreign persons 5. Treaty reductions for dividends, interest and royalties

Income earned by foreign persons (NRA, foreign corporations/partnerships/estates/trusts) is classified as:

1. Fixed, determinable, annual or periodic income (FDAP) (generally investment income) 2. Effectively connected income (ECI) (trade or business income)

Two US withholding regimes apply to investment-type income:

1. Foreign Account Tax Compliance Act (FATCA) 2. Withholding on payments of fixed, determinable, annual or periodic income (FDAP)

US property includes:

1. Stock and debt obligations issued by a US person 2. Certain trade/service receivables acquired from a related US person where obligor is a US person Ex. Buy receivables (AR) from a US person 3. Tangible property, real & personal, located in the US 4. Right to use intangible property in the US Ex. Trademarks, copyrights, franchises, patent Valued at average adjusted basis less any liability on the last day of each quarter of the CFC's tax year

US property does not include:

1. Stock or debt obligations of *unrelated* domestic corporations - §956(c)(2)(F) 2. Certain debt obligations issued by *unrelated* U.S. *non-corporate persons* - §956(c)(2)(M) 3. Certain securities acquired and held in the ordinary course of its business by a CFC that is a dealer in securities - §956(c)(2)(L) 4. Obligations of the United States government 5. Money or deposits with US bank Valued at average adjusted basis less any liability on the last day of each quarter of the CFC's tax year

Ace, Inc., a domestic corporation, has $2 million gross income and a $50,000 expense, all related to real estate activities (sales and rentals). How is the $50,000 expense allocated and apportioned based on the following information? foreign US total sales $1,000,000 $500,000 $1,500,000 rentals $400,000 $100,000 $500,000 total $1,400,000 $600,000 $2,000,000

1. allocate expenses to income $50,000 expenses allocate between sales and rentals $50,000 x (1.5/2) = $37,500 sales $50,000 x (0.5/2) = $12,500 rentals 2. apportion between US & foreign sales: $37,500 x (1/1.5) = $25,000 foreign $37,500 x (0.5/1.5) = $12,500 US rentals: $12,500 x (4/5) = $10,000 foreign $12,500 x (1/5) = $2,500 US

steps of sourcing deductions

1. allocate expenses to income 2. apportion expenses between US and foreign sources

transfer pricing methods for transfers of tangible property

1. comparable uncontrolled price method 2. resale price method 3. cost plus method 4. comparable profits method 5. profit split method

transfer pricing methods for transfers of intangible property

1. comparable uncontrolled transaction method 2. comparable profits method 3. profit split method

James Brown, Inc. (JBI), a domestic corporation with operations in Canada, has the following items in 2020: Transaction Total taxable income for the tax year of $550,000 1. $150,000 branch net income in Canada with taxes paid to Canada of $60,000 2. $4,250 payment* received for interest from Royal Bank of Canada (RBC) *RBC withheld $750 in at-source withholding Which limitation basket does each transaction go into?

1. foreign branch 2. passive

Della, Inc., a domestic corporation with a manufacturing facility in Mexico, has the following items in 2020: Transaction Total taxable income for the tax year of $750,000 1. $350,000 in taxable income from sales attributable to foreign sources with $105,000 in taxes paid to foreign jurisdictions 2. $8,500 payment* received for dividends from Nestle S.A. (a Swiss corporation) *Nestle withheld $1,500 in at-source withholding Which limitation basket does each transaction go into?

1. general 2. passive

Treasury Regulations under Sec. 482 provide guidance to determine an arm's length standard in various transactions, such as:

1. loans or advances 2. performance of services 3. sales, transfers, or use of intangible property 4. sales, transfers, or use of tangible property 5. cost sharing arrangements

Pine Corporation (incorporated in Country P) is a wholly owned CFC of Oak Corporation (a US corporation). Otis (incorporated in the United Kingdom) is a wholly owned CFC of Oak Corporation. Income Item - Pine 1. Dividends from an unrelated person of $100,000 2. Interest from a related corporation (incorporated in Country D) of $200,000 3. Income from rental of equipment $400,000 (from unrelated party) 4. Foreign currency gain of $150,000 5. $250,000 in sales of inventory purchased from Otis in the UK and sold to customers in Hong Kong 6. $300,000 in sales of products purchased from Otis; Pine performed substantial manufacturing activities in Country P and sells to customers in Country P. 7. $100,000 in service income related to Pine preforming the installation and maintenance of machines sold by Otis in Country T Determine if Subpart F income, and if so, what type of Subpart F income.

1. yes; Foreign personal holding company income 2. yes; foreign personal holding company income 3. no 4. yes; foreign personal holding company income 5. yes; foreign base company sales income 6. no 7. yes; foreign base company services income

The Participation Exemption (§245A Dividends-Received Deduction)

100% deduction on dividends received from a corporation The new dividends-received deduction effectively creates a territorial system for domestic corporations operating abroad through a foreign corporation. No credit or deduction is allowed for any foreign taxes (including withholding taxes) paid or accrued with respect to a dividend that qualifies for the new Code Sec. 245A dividends-received deduction because the underlying foreign-source income is exempt from U.S. tax.

On June 1, 2019 Boyle Corporation (a US C corporation) purchased 12% of Genevieve Corporation (a foreign corporation located in Country X). Assume Genevieve's 2019 income is $5 million. Country X's tax rate is 15%, while the US tax rate is 21%. Country X has no dividend withholding tax. On December 31, 2019 Genevieve distributes its current year after-tax earnings to its shareholders in proportion to stock ownership. Assume Boyle sold its shares in Genevieve on April 1, 2020. Determine if Boyle eligible for the participation exemption.

2019: no participation exemption; does not meet holding period requirement $5M x 15% = $750,000 Country X tax $5M - $750,000 taxes paid = $4.25M x 12% share = $510,000 distribution eligible for Sec. 902 indirect credit $750,000 tax paid x 12% = $90,000 foreign taxes paid attributable to Boyle's share of income $510,000 + $90,000 = $600,000 dividend amount; $90,000 foreign taxes paid

Ronco, a US manufacturer, derives 60% of its sales revenue from foreign sources and 30% of its gross income from foreign sources. Ronco incurs $100 million of research and experimentation expenses in the US, none of which is legally mandated. How is the R&E allocated if the gross method is elected?

25% -> R&E location -> US -> $25M remaining 75% -> allocate based on gross income (US vs foreign) 30% x $75M = $22.5M foreign $52.5M US total foreign: $22.5M total US: $77.5M is foreign residual at least 50% of foreign residual for sales method? YES, because $30M x 50% = $15M < $22.5M therefore, can elect gross income method

non-legally mandated research and experimentation expense allocation: gross income method

25% is apportioned to location of research (where the activities accounting for more than 50% of the expenses were performed.) Remaining is allocated based on gross income (US vs foreign) 25% -> R&E location remaining 75% (residual) -> allocate based on gross income (US vs foreign) What we allocated here for foreign must be *at least 50%* of foreign sales method residual

At what rate is FATCA withheld?

30%

How is the branch profits tax calculated?

30% of dividend equivalent amount (DEA) DEA = US ECI-related earnings and profits (US net income less taxes) + decrease in US net equity - increase in US net equity net equity = assets - liabilities

What is the required holding period for stock?

366 days. (Must own at least 10% of voting stock in the foreign corporation for 366 days). if ex-dividend date is Dec. 11, go back one year to 12/11/19 and forward one year to 12/11/20; must own stock for 366 days during this time period

What geographical areas are included in US source income?

50 states and DC; NOT US possessions

50% -> R&E location -> US -> $50M remaining 50% -> based on sales revenue 60% x $50M = $30M foreign $20M US total foreign: $30M total US: $70M

foreign tax credit limitation

= total US tax liability * (foreign source taxable income / total worldwide taxable income)

Mechanisms to Prevent Double Taxation: CFC stock basis adjustments

A US shareholder increases its basis in the stock of a CFC by the amount of Subpart F inclusion. When the PTI (previously taxed income) is distributed, the US shareholder treats the distribution as a nontaxable return of capital, reducing its stock basis.

Credit-based Jurisdiction (also known as residence-based)

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. Taxes on worldwide income but allows a foreign tax credit

Why is a treaty important to a nonresident worker in the US?

A nonresident worker in the United States generally will be subject to U.S. tax on his or her U.S. source wages. A treaty may exempt such wages from U.S. tax if the worker is in the United States for less than a prescribed number of days or the total wages do not exceed a stated amount.

Deemed-Repatriation Regime (Transition Tax) for 2017 Only § 965

A transition tax for 2017 requires every US shareholder to include the accumulated earnings and profits of a foreign subsidiary as Subpart F income, but taxed at a tax rate of 15.5% for cash and cash equivalents and 8% for remaining E&P. US shareholders can elect to pay the transition tax in eight installments: Years 1-5 8% Year 6 15% Year 7 20% Year 8 25% These percentages are percentages of the tax due

Why is a treaty important to a nonresident investor in US stocks and bonds?

A treaty often reduces (or eliminates) the U.S. statutory withholding tax (30 percent) otherwise imposed on U.S. source interest and dividends paid to a nonresident investor.

The Base Erosion Anti-Abuse Tax (BEAT)

Added as a part of the Tax Cuts and Jobs Act of 2017, BEAT focuses on high amounts of deductible payments by US subsidiaries (or any US C-corporation or foreign corporation with US ECI) to related foreign parties, which reduce the US tax base, hence the "base erosion" title. o The BEAT tax is similar to an alternative *minimum* tax. o Applies to C corporations with average gross receipts of more than $500M over the prior 3 year period AND our total base erosion payments divided by all deductions must be >= 3%

In 2020, Gray's Subpart F income is $100,000 and no distributions have been made during the year. Determine if each shareholder is a US Person, a US shareholder and each shareholder's Subpart F income inclusion. shareholders voting power classification Alan 30% US citizen Bill (Alan's son) 9% US citizen Carla 40% citizen & resident of Germany Dora 20% US resident Ed 1% US resident

Alan: US person & US shareholder; 2020 income inclusion = $30,000 Bill (Alan's son): US person & US shareholder; 2020 income inclusion = $0 (don't report income for constructive ownership) Carla: not US person or US shareholder; 2020 income inclusion = $0 Dora: US person and US shareholder; 2020 income inclusion = $20,000 Ed: US person, not US shareholder; 2020 income inclusion = $0 this is a CFC because 30% + 9% (constructive ownership, so included) + 20% = 59% > 50%

Distinguish between allocation and apportionment in sourcing deductions in computing the foreign tax credit limitation.

Allocation is the qualitative process of associating a deduction with a specific item or items of gross income for purposes of computing foreign source taxable income. Apportionment is the quantitative process of calculating the amount of a deduction that is associated with a specific item or items of gross income for purposes of computing foreign source taxable income.

What does § 904(k) provide?

Allows individual taxpayers to elect out of the foreign tax credit limitation calculation. For individuals who have paid less than $300 (less than $600 for married filing joint) in foreign taxes. Thus, they can take a foreign tax credit equal to foreign taxes paid. *corporations not eligible for election*

Global Intangible Low-Tax Income

Amount of income from a controlled foreign corporation (CFC) in excess of a 10% return on assets **Can't carryback or carryforward any excess credits in GILTI category

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.

International boycott factor income § 999

Any income derived by the CFC from the participation in or cooperation with an international boycott against a particular nation.

special sourcing rule: How are non-legally mandated research and experimentation expenses allocated?

Apportion using either sales method or gross income method; must elect the gross income method

Owl Vision Corporation (OVC) is a North Carolina corporation engaged in the manufacture and sale of contact lens and other optical equipment. The company handles its export sales through sales branches in Belgium and Singapore. The average tax book value of OVC's assets for the year was $200 million, of which $160 million generated U.S. source income and $40 million generated foreign source income. OVC's total interest expense was $20 million. What amount of the interest expense will be apportioned to foreign source income under the tax book value method?

Apportionment using tax book value Tax book value of U.S. assets = $160 million Tax book value of foreign assets = $40 million Interest apportioned to U.S. source income: $160,000,000/$200,000,000 × $20 million = $16 million Interest apportioned to foreign source income: $40,000,000/$200,000,000 × $20 million = $4 million

How is income sourced outside the US?

As foreign-sourced income

FDAP treated as ECI: What are the two tests to determine if income is effectively connected with the conduct of a US trade or business vs FDAP?

Asset-use Test: The income is derived from assets used in or held for use in the conduct of the US trade or business. E.g., rents from lease of personal property Business-activities: The activities of the US trade or business were a material factor in generating the income. E.g., interest income from accounts receivable

method of sourcing: Income from the sale of inventory produced by the Taxpayer ("make it")

Based on location of production assets

method of sourcing: dividends

Based on residence of corporation paying the dividends NOTE: If a foreign corporation earns 25% or more of its gross income from income effectively connected with a US trade or business for the three preceding tax years, then that percentage is treated as 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 -Foreign corporations/partnerships engaged in US trade or business is US source

method of sourcing: Gain on the sale of patents and other intangible property

Based on residence of seller

method of sourcing: Gain on the sale of personal property

Based on the residence of the seller NOTE: Includes corporation stock; based on residence of owner of stock

method of sourcing: personal services income

Based on where services are performed

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 Royalties: based on where they're protected from a legal perspective

Territorial-based Jurisdiction (also known as source-based)

Basing tax jurisdiction on a territorial connection means that a country looks to the connection that a person or income may have to its country. Taxing transactions that occur within the country (foreign income is tax exempt if this method is used) participation exemption is example of territorial-based legislation

Foreign Branch category income

Branch of corporation in a foreign country (QBU - qualified business unit) Has its own accounting records and books Is a trade or business *not* a separate entity

Prior to 1962, how did US entities achieve income deferral?

By billing a foreign corporation in a low tax country for inventory at an artificially low price and then having the foreign corporation bill customers at the market rate for the inventory.

Income Inclusion Amount § 951A

CFC tested income* ─ (10% of the quarterly average adjusted basis of depreciable assets ─ net interest expense) *excluding Subpart F income and amounts excluded under Subpart F under the high-tax kickout exception *basically, net income after foreign taxes The foreign tax credit is limited to 80% of foreign taxes deemed paid, but Sec. 78 requires a gross-up of 100%. CFC net income <subpart F> <high tax kickout> <foreign taxes> = CFC tested income <10% of depreciable assets> <net interest expense> = GILTI inclusion under sec 951A + Sec 78 foreign taxes paid (100%) / deemed paid credit (80%) =total inclusion x 50% = sec 250 deduction

"conclude" a contract

Can write up a contract and sign on your behalf

Bribes, Kickbacks and Other Illegal Payments

Cannot defer income recognition for the amount equal to amounts paid for bribes, kickbacks and other illegal payments.

How does the IRS receive this tax on FDAP?

Collect it from the payer in the US. If payer fails to withhold on FDAP, responsible for tax as well as penalties.

US citizen

Could be born in the US, born to a parent who is a US citizen, or naturalized

Robin, Inc., a foreign corporation, has a US branch operation with the following results for the year. Pretax earnings & profits effectively connected with a US trade or business $2,000,000 US corporate tax at 21% 420,000 Remittance to home office 1,000,000 US Net Equity January 1, 2020 $4,000,000 US Net Equity December 31, 2020 $4,750,000 What is Robin's DEA and branch profits tax?

DEA = US ECI-related earnings and profits (US net income less taxes) + decrease in US net equity - increase in US net equity DEA = $2,000,000 - $420,000 - $750,000 = $830,000 branch profits tax = 30% x DEA = $249,000

Robert is a citizen of Germany. He decides to come to the United States to open a car dealership in Chicago. Robert does not obtain a Green Card but procures a visa to work in the United States. He is physically present in the United States during the following periods: 20X1 (April 1 through July 30) 20X2 (June 1 through August 15) a) How is Robert classified in 20X2? Choose the correct classification and explain why it is correct.

Days present in 20X2: 30 + 31 + 15 = 76 Days present in 20X1: (30 + 30 + 30)/3 = 30 Total days present: 106 Robert is a nonresident alien because he does not meet the green card test or the substantial presence test.

In 2014, Jones Corp. (a CFC) reports taxable income of $75,000 from its operations in its foreign country of incorporation. Jones received $2,500 of dividends from an unrelated party. Assume Jones has gross income of $125,000. Does Jones Corp. have Subpart F income for 2014?

De-minimis rule Subpart F: $2,500 less than $1M $2,500/125,000 = 2% <5% gross income No, the dividend is less than the lesser of $1 million and 5% of gross income.

Don Dealer ("Dealer") is a citizen of the United Kingdom. He decides to come to the United States to open a car dealership in Detroit. Dealer does not obtain a Green Card, but he procures a visa to work in the United States. He is physically present in the United States during the following periods: 20X1 (May 1 through August 30) 20X2 (August 1 through December 30) b) How will the US tax Dealer's income in 20X2? Choose the correct answer and explain why it is correct.

Dealer is taxed on his worldwide income because he is a resident alien

Foreign Corporation: timing of US taxation

Deferral

What are "definitely related" deductions?

Definitely related deductions are allocated to the particular item of income to which the deductions are associated. Example: manufacturing costs.

foreign branch: general business factor

Does not have minimum capitalization requirements

Nonresident aliens (NRA)

Does not live in US and is not a US citizen (or don't meet requirements of resident alien)

How is tax calculated on ECI?

ECI taxed on net income at graduated rates; individual files 1040NR; corporation files 1120F

Sombrero Corporation, a U.S. corporation, operates through a branch in Espania. Management projects that the company's pretax income in the next taxable year will be $100,000: $80,000 from U.S. operations and $20,000 from the Espania branch. Espania taxes corporate income at a rate of 30 percent. b. Management plans to establish a second branch in Italia. Italia taxes corporate income at a rate of 10 percent. What amount of income will the branch in Italia have to generate to eliminate the excess credit generated by the branch in Espania?

Each dollar of foreign taxable income earned in Italia generates an excess FTC limitation of $0.11 [$1 × (21% - 10%)]. Sombrero must generate enough low-tax general category foreign source taxable income to eliminate the $1,800 excess credit. The excess credit will be eliminated if Sombrero can generate $16,364 of income in Italia ($1, 800/.11). Foreign income taxes Espania ($20,000 × 30%) = $6,000 Italia ($16,364 × 10%) = 1,636 Total = $7,636 FTC Limitation: Foreign source taxable income $36,364 Total taxable income ($100,000 + $36,364) 136,364 Precredit U.S. tax (21% × $136,364) $28,636 FTC Limitation: ($36,364/$136,364 × $28,636) = $7,636 Excess foreign tax credit ($7,636 - $7,636) = $0

What are "eligible entities" per Reg. §301-7701-3(b)?

Eligible entity: an entity that is not a "per se" entity Per se entity: an entity that is publicly traded in its home country.

foreign branch: US treatment of foreign taxes paid

Eligible for direct foreign tax credit under sec. 901

General category income

Everything not foreign branch, passive, or GILTI Ex. Financial services income, dividends from subsidiary

US-source income effectively connected to a US trade or business Rule

Excluded from Subpart F because it is already taxed by the US at the CFC level, assuming that it is not exempt from US taxation or reduced rate of tax by a tax treaty.

Why does the United States not allow exclusion on all foreign source income earned by a controlled foreign corporation?

Exclusion of U.S. taxation on all foreign source income earned through a foreign subsidiary would invite tax planning strategies that shift income to low-tax countries to minimize the taxpayer's worldwide tax liability. U.S. taxpayers could transfer investment assets to corporations located in low (no) tax countries (tax havens) and avoid U.S. tax on such low-tax or tax-exempt income.

method of sourcing: Gain on the sale of depreciable property

Gain may include 2 items: 1. depreciation recapture (follows prior depreciation sourcing) 2. remaining gain (based on where title passes)

What are "not definitely related" deductions?

Expenses not definitely related are allocated to all gross income because they are not directly associated with a particular item of gross income. Example: medical expenses, property taxes, standard deduction

Describe the coordination between FATCA and FDAP.

FATCA applies first. If FATCA doesn't apply then look at FDAP.

French Bank deposits $20 million in US Bank. French Banks earns $600,000 during 2020. What withholding, if any, will apply to the interest payment in the following situations: 2) French Bank completes Form 8966 FATCA Report.

FATCA does not apply. payment is exempt from FDAP because it is an interest payment. If it was a dividend, 30% withholding would apply unless a treaty was in place.

Linetti, Inc. (a US corporation) earns $1,000,000 in DE income and has $250,000 in assets used to generate DE income. Linetti's DE income is 60% foreign-derived. What is Linetti's FDII deduction?

FDII = (Total DE Income * - 10% adjusted basis of assets**) X (foreign derived DE income***/total DE income) FDII = ($1M - (10% x $250,000) x 60% FDII = $585,000 FDII deduction = $585,000 x 37.5% = $219,375

Primary difference between GILTI and FDII

FDII is income earned directly by a domestic corporation whereas GILTI is income earned by the CFC but taxed to the US shareholder under § 951A.

permanent establishment excludes:

Facility for storage/display/delivery of merchandise, facility used solely for auxiliary functions (ex. Collecting info on potential customers), or presence of a foreign subsidiary/branch

True or False: All dividend income received by a U.S. taxpayer is classified as passive category income for foreign tax credit limitation purposes. Explain.

False. Dividends received from a 10%-or-more owned foreign corporation by a U.S. corporation are eligible for the 100% dividends received deduction and are exempt from U.S. taxation. Dividends not eligible for the 100% dividends received deduction are treated as passive category income.

True or False: All foreign taxes are creditable for U.S. tax purposes. Explain.

False. Only foreign income taxes are creditable for U.S. tax purposes. Other foreign taxes (property, value-added, payroll) can only be deducted in computing taxable income. In addition, foreign taxes associated with dividends eligible for the 100% dividends received deduction are not creditable. Only 80% of foreign income taxes associated with the GILTI deemed dividend are creditable.

True or False: Non-subpart F income always qualifies for exclusion from U.S. taxation. Explain.

False. Outbound payments that do not exceed three percent of total deductions are not subject to the 10% BEAT minimum tax.

True or False: Subpart F income is always treated as a deemed dividend to the U.S. shareholders of a controlled foreign corporation. Explain.

False. Subpart F income is not treated as a deemed dividend if the total amount falls below a prescribed de minimis amount, which is the lesser of 5 percent of gross income or $1 million. In addition, a U.S. shareholder can elect to exclude "high tax" subpart F income from the deemed dividend rules. High-tax subpart F income is income taxed at an effective tax rate that is 90 percent or more of the highest U.S. statutory rate. For a U.S. corporation, the "high tax" rate currently is 18.9 percent (.90 x .21).

How can the organizational form help a US person reduce worldwide taxation?

Foreign subsidiary: income taxed as it is repatriated; may be eligible for a participation exemption; we have control over timing of the income, so could use foreign sub for profitable business lines maximize foreign income to maximize foreign tax credit US corporations who operate in internationally by way of branches or flow-through entities (partnerships) are subjected to immediate taxation on all income and loss from this foreign income. Generally, a US corporation which owns a foreign corporation will not be subjected to US taxation on foreign income until this income is repatriated to the US corporation by way of a dividend (may be eligible for participation exemption), interest, rent, royalty, or management fee. In this situation, the US corporation has a potential deferral of US taxation of the foreign income earned by these foreign corporations. use of transfer pricing to shift income from high tax countries to low tax countries

Exports, licenses, branches, and partnerships: US taxation

Full taxation as earned in US

USP, a domestic corporation, operates abroad through three wholly-owned foreign corporations, Fco1 through Fco2, each of which is organized in a different foreign country. During the current year, Fco1 has total gross income of $10 million, including $400,000 of interest income that qualifies as foreign personal holding company income, and $9.6 million of gross income from the sale of goods that Fco1 manufactured in its country of incorporation. Fco2's current year earnings and profits are $30 million, which consists of $40 million of foreign personal holding company income and a $10 million loss from sales of goods that Fco2 manufactured in its country of incorporation. Determine the amount of Subpart F income, if any, that each controlled foreign corporation must report.

Fco1 has no Subpart F income. Although the $400,000 of interest income qualifies as foreign personal holding company income, the $9.6 million of income from the sale of goods that Fco1 manufactured in its country of incorporation does not qualify as foreign base company sales income (Code Sec. 954(c) and (d)). Therefore, under the de minimis rule, no part of Fco1's gross income is treated as Subpart F income because Fco1's gross Subpart F income of $400,000 is less than both $1 million and 5% of its total gross income (5% of $10 million total gross income equals $500,000) (Code Sec.954(b)). Fco2's Subpart F income is limited to its current year earnings and profits of $30 million. The $10 million of excess Subpart F income is carried forward to succeeding years and is treated as Subpart F income to the extent Fco2 has any excess earnings and profits in a subsequent year (Code Sec. 952(c)).

Taxation of Effectively Connected Income (ECI)

For a foreign person's noninvestment income to be subject to US taxation, the foreign person must be considered engaged in a US trade or business (earn "effectively connected income (ECI)). While ECI is taxed for US purposes, it is NOT subject to FDAP withholding rules. taxed @ *graduated* rates on *net* income

How does the US tax foreign activities of non-US persons?

Foreign citizens/corps: taxed only on income within the US

What income is eligible for the participation exemption?

Foreign source income ONLY. Must be a dividend distribution from the foreign corporation paid out of earnings and profits.

Gameco, a U.S. corporation, operates gambling machines in the United States and abroad. Gameco conducts its operations in Europe through a Dutch B.V., which is treated as a branch for U.S. tax purposes. Gameco also licenses game machines to an unrelated company in Japan. During the current year, Gameco paid the following foreign taxes, translated into U.S. dollars at the appropriate exchange rate: foreign taxes amount (in $) national income taxes $1,000,000 city (Amsterdam) income taxes $100,000 value-added tax $150,000 payroll tax (employer's share of social insurance contributions) $400,000 withholding tax on royalties received from Japan $50,000 Identify Gameco's creditable foreign taxes.

Gameco's creditable foreign taxes are those taxes that qualify as income taxes or taxes paid in lieu of income taxes. The creditable income taxes are the national income taxes and the city of Amsterdam income taxes. The withholding tax is creditable because it is imposed "in lieu" of an income tax. Therefore, the total creditable foreign taxes are $1,150,000 ($1,000,000 + $100,000 + $50,000).

What are some examples of FDAP income per IRC § 871(a)(1)(A)?

Generally passive income: dividends, rents, royalties. Also includes salaries/wages and annuities.

Will a country tax income with which it has no connection?

Generally, no.

While a credit is typically more advantageous for a taxpayer, why might a taxpayer choose to deduct foreign taxes paid rather than take a credit?

Generally, take credit, but if corporation does not expect to have income tax in the next 10 years, might choose to take deduction and carryforward the credit.

Tenco, a domestic corporation, manufactures tennis rackets for sale in the United States and abroad. Tenco owns 100% of the stock of Teny, a foreign sales subsidiary that was organized in Year 1. During Year 1, Teny had $15 million of foreign base company sales income, paid $1 million in foreign income taxes, and distributed no dividends. During Year 2, Teny had no earnings and profits, paid no foreign income taxes, and distributed a $14 million dividend. Assuming the U.S. corporate tax rate is 21%, what are the U.S. tax consequences of Teny's Year 1 and Year 2 activities?

Generally, the undistributed earnings of a foreign subsidiary are not subject to U.S. tax until they are distributed to the U.S. parent as a dividend. However, Subpart F requires a U.S. shareholder of a controlled foreign corporations (CFC) to include in gross income a deemed dividend equal to the shareholder's pro-rata share of the CFC's Subpart F income and any earnings invested in U.S. property (Code Sec. 951). Subpart F income is comprised of several categories of tainted income, including foreign base company sales income (Code Sec. 954). A domestic corporation that owns 10% or more of a CFC's voting stock can claim a deemed paid foreign tax credit equal to the amount of the foreign corporation's foreign income taxes properly attributable to the Subpart F income inclusion (Code Sec. 960). Because Teny is a CFC, in Year 1 Tenco must include in gross income a deemed dividend equal to its share of Teny's net Subpart F income, which is $14 million [$15 million of Subpart F income − $1 million of foreign income taxes]. Tenco may claim a deemed-paid credit for the $1 million of foreign income taxes that Teny paid on the Subpart F income. With the Code Sec. 78 gross-up, Tenco has $15 million of foreign-source general limitation income, and a pre-credit U.S. tax of $3.15 million [21% rate × $15 million of taxable income]. Thus, the residual U.S. tax on Teny's Subpart F income is $2.15 million [$3.15 million pre-credit U.S. tax − $1 million credit]. In Year 2, Tenco can exclude the $14 million dividend from U.S. taxation because it represents a distribution of previously taxed Subpart F income. In addition, Tenco cannot claim a deemed paid credit because it claimed a credit for Teny's income taxes in Year 1

Spartan Corporation, a U.S. company, manufactures green eyeshades for sale in the United States and Europe. All manufacturing activities take place in Michigan. During the current year, Spartan sold 10,000 green eyeshades to European customers at a price of $10 each. Each eye shade costs $4 to produce. All of Spartan's production assets are located in the United States. For each independent scenario, determine the source of the gross income from sale of the green eyeshades b. Half of Spartan's production assets are located outside the U.S.

Gross profit from the sales is $60,000 (10,000 units × {$10 - $4}). 50 percent of gross profit is treated as foreign-source because half of the production assets are located outside the U.S.

Spartan Corporation, a U.S. company, manufactures green eyeshades for sale in the United States and Europe. All manufacturing activities take place in Michigan. During the current year, Spartan sold 10,000 green eyeshades to European customers at a price of $10 each. Each eye shade costs $4 to produce. All of Spartan's production assets are located in the United States. For each independent scenario, determine the source of the gross income from sale of the green eyeshades a. All of Spartan's production assets are located in the U.S

Gross profit from the sales is $60,000 (10,000 units× {$10 - $4}). 100 percent of gross profit is sourced based on the location of the production assets.

Hans is a citizen and resident of Argentina. Hans does not hold a green card, and Argentina does not have an income tax treaty with the United States. At the start of Year 1, Hans paid $2.5 million for an apartment building located in the suburbs of Washington, D.C. Hans does not actively manage the building, but rather leases it to an unrelated property management company that subleases the building to the tenants. During Year 1, Hans had rental income of $300,000 and operating expenses (depreciation, interest, insurance, etc.) of $220,000. At the start of Year 2, Hans sold the building for $2.9 million. Hans' adjusted basis in the building at that time was $2.4 million. What are the U.S. tax consequences of Hans' U.S. activities?

Hans is a nonresident alien. The United States taxes the gross amount of a nonresident alien's U.S.-source investment income through a flat rate withholding tax. In contrast, any income effectively connected with the conduct of a U.S. trade or business is taxed on a net basis at the regular graduated rates (Code Sec. 871). Hans is probably not engaged in a U.S. trade or business since he has no active involvement in the management of the rental property. Absent a Code Sec. 871(d) election (which will not be tested in our class), Hans' Year 1 gross U.S.-source rental income of $300,000 is subject to a 30% withholding tax. Hans' U.S. tax for Year 1 is $90,000 [$300,000 × 30%], even though he realized net income from the property of only $80,000 ($300,000 of rentals - $220,000 of operating expenses). Even if the U.S. had an income tax treaty with Argentina, tax treaties typically do not provide any withholding tax reductions or exemptions for rental income. The $500,000 gain on the sale of the apartment building in Year 2 is taxed in the same manner as effectively connected income, which equals the gain on sale of $500,000 ($2.9 million amount realized - $2.4 million adjusted basis). This transaction will be subject to FIRPTA withholding of 15% (treated as a tax prepayment, not a payment of the tax itself).

How do tax treaties mitigate double taxation?

Host country does not tax taxpayers from home country and vice versa provides for exemption of certain types of income and/or lower withholdings

Fleming Ltd, a CFC and calendar-year taxpayer, earned no Subpart F income for the taxable year. On July 3, 2019, Fleming lends $100,000 to Lynn, a calendar-year taxpayer, its sole US shareholder. How much of a constructive dividend does Lynn have?

How much US property does the CFC have? loan is considered US property calculate loan balance as of end each of quarter: Q1: $0 Q2: $0 Q3: $100,000 Q4: $100,000 $200,000/4 = $50,000 increase in US property; current year income inclusion for Lynn

The Full Inclusion Rule

If *gross* foreign base company and *gross* insurance income exceeds *70%* of the CFC's total gross income, then *all* CFC gross income is Subpart F.

The "De Minimis" Rule

If *gross* foreign base company income + *gross* insurance income for the tax year is less than both: 5% of total gross income AND $1,000,000, then no part of the qualifying foreign base company income or insurance is treated as Subpart F income.

Elective High-tax Rule

If an election is made by the controlling shareholders of a CFC, *net* foreign base company income (FBCI) or net insurance income of the CFC will not include *net* income subject to an effective foreign tax that is *greater than 90%* of the maximum US rate (i.e., 18.9%)

non-legally mandated research and experimentation expense allocation: sales method

If more than 50% of R&E are performed either in the US or foreign, then the taxpayer apportions 50% of non-legally mandated R&E to that source. first 50% -> R&E location remaining 50% (residual) -> allocate based on sales (US vs foreign)

Insurance Income § 953

Income attributable to insuring risk of loss outside the country in which the CFC is organized.

Earnings Derived in Certain Foreign "Black-Listed" Countries

Income from "blacklisted" countries (past and present): Iran, North Korea, Sudan and Syria.

Foreign Base Company Income § 954: Foreign base company services income

Income from services performed on behalf of a related party outside of our CFC's country of incorporation Personal services include technical, managerial, engineering, architectural, scientific, industrial, commercial, or similar

Foreign Base Company Income § 954: Foreign base company sales income

Income generated by the CFC where the CFC has very little connection with the process that generates the income and a related party is involved. Three requirements: 1.Related party sale: purchased from or sold to related party 2.Manufactured outside of CFC country of incorporation by someone other than the CFC 3. Sold for use, consumption, or disposition outside of CFC country of incorporation Property basically must cross TWO borders after manufacturing to be FBC sales income and the CFC does not manufacture it. if CFC makes substantial improvements to product after manufacture, could treat product as being manufactured within CFC country

foreign subsidiary: US taxation

Income subject to tax as its repatriated via dividend

US corporations/partnerships

Incorporated/organized under the laws of a state in the US or DC

Passive category income

Interest, dividends, rents, annuities, royalties, gains on sale of passive income producing property, net commodity gains, and foreign currency gains *apply look-through rules for income from CFCs; look through to entity which paid dividend and determine how that entity makes its money; if CFC income is attributable to trade/business income, not passive *High tax income may be kicked out and assigned to another category

Mackinac Corporation, a U.S. corporation, reported total taxable income of $5 million. Taxable income included $1.5 million of foreign source taxable income from the company's branch operations in Canada. All of the branch income is foreign branch income. Mackinac paid Canadian income taxes of $375,000 on its branch income. Compute Mackinac's allowable foreign tax credit.

Mackinac Corporation's precredit U.S. tax is $1,050,000 ($5,000,000 × 21%). The company's foreign tax credit limitation is computed as: $1,500,000 / $5,000,000 × $1,050,000 = $315,000. Mackinac's allowable foreign tax credit is limited to $315,000, creating an "excess credit" of $60,000 ($375,000 - $315,000), which can be carried back one year and carried forward 10 years.

Cupcake Bakery, a US corporation, makes cupcakes at its US manufacturing facility near Burlington, VT. The following information relates to Cupcake's 2019 activity. Determine whether the income is foreign-source or US source. All amounts are US dollars. 4. Cupcake's total cupcake sales for the year are $7,500,000: $2,500,000 of cupcakes to Canadian supermarkets and $5,000,000 of cupcakes to US supermarkets. Assume all sales are FOB destination.

Manufacturing these cupcakes; $75,000 US source

foreign subsidiary: general business factor

May have a better local image than branch

USCo owns 100 percent of the following corporations: Dutch NV, Germany AG, Australia PLC, Japan Corporation, and Brazil SA. During the year, the following transactions took place. Determine whether the transaction results in subpart F income to USCo. a) Germany AG owns an office building that it leases to unrelated persons. Germany AG engaged an independent managing agent to manage and maintain the office building and performs no activities with respect to the property.

No. Rental income received from unrelated persons is not FPHC income if it is derived in the active conduct of a trade or business. Rents are considered derived in the active conduct of a trade or business if the CFC regularly performs active and substantial management and operational functions during the lease period. This rental income would not be FPHC income.

USCo owns 100 percent of the following corporations: Dutch NV, Germany AG, Australia PLC, Japan Corporation, and Brazil SA. During the year, the following transactions took place. Determine whether the transaction results in subpart F income to USCo. d) Australia PLC purchased goods manufactured in Australia from an unrelated person and sold them to Japan Corporation for use in Japan.

No. The income from sales to Japan Corporation would not be foreign base company sales income because the goods were manufactured in the CFC's country of incorporation.

green card test

Non-US citizen holds a green card (permanent resident visa) at any time during the year

substantial presence test

Non-US citizen needs to be in US for at least 183 days first part: *Must* be present at least 31 days in the current year (any part of day = full day) second part: Formula: current year # of days + (1/3 * prior year days present) + (1/6 *second prior year days present) If equals or exceeds 183 days, are considered a resident alien must pass both tests International students exempt 5 years International teachers exempt 2 years

foreign corporations/partnerships

Not created/organized in US

foreign subsidiary: US treatment of foreign taxes paid

Not eligible for foreign tax credit IF they've taken the participation exemption

Foreign Corporation: US taxation

Not taxed in US until there is some sort of connection to the US (until it is repatriated); NOTE: dividends may be eligible for a participation exemption -deemed inclusion (subpart F income)

During 2020, FTrike, a foreign subsidiary, distributes a $10 million dividend to Trikeco, a U.S. C corporation. FTrike has post-2017 undistributed E&P of $90 million and post-2017 foreign income taxes of $36 million. Assume that the U.S. corporate tax rate is 21% and the dividend incurs a withholding tax of 5%. As a result of the dividend, what is the foreign tax due and the U.S. tax due?

On the $10 million dividend distribution, the foreign withholding tax due will be $500,000 (5% of the $10 million dividend). Because Trikeco is a U.S. C corporation, Trikeco should be entitled, assuming all the requirements are met, to the participation exemption on the dividend. As a result, there will not be any U.S. tax due and the $500,000 withholding, which is not creditable, is an out-of-pocket cost. Unlike previous law, Trikeco is not entitled to a deemed-paid foreign tax credit for the taxes paid by FTrike.

personal services income: 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 $3,000; and 3) services are performed for an NRA, foreign corporation or foreign partnership or for the foreign office of a domestic corporation. Tax treaty in place to extend 1) to 183 days and remove 2)

Chapeau Company, a U.S. corporation, operates through a branch in Champagnia. The source rules used by Champagnia are identical to those used by the United States. For 2018, Chapeau has $2,000 of gross income: $1,200 from U.S. sources and $800 from sources within Champagnia. The $1,200 of U.S. source income and $700 of foreign source income are attributable to manufacturing activities in Champagnia (foreign branch income). The remaining $100 of foreign source income is passive category interest income. Chapeau has $500 of expenses other than taxes, all of which are allocated directly to manufacturing income ($200 of which is apportioned to foreign sources). Chapeau paid $150 of income taxes to Champagnia on its manufacturing income. The interest income was subject to a 10 percent withholding tax of $10. Compute Chapeau's allowable foreign tax credit in 2018.

Precredit U.S. tax Total taxable income ($2,000 - $500) = $1,500 Precredit U.S. tax ($1,500 × 21%) = 315 FTC limitation calculations Foreign branch income (manufacturing) Foreign source taxable income ($700 - $200) = $500 FTC limitation: $500/$1,500 × $315 = 105 Foreign tax imposed = $150 Passive category income Foreign source taxable income ($100 - $0) = $100 FTC limitation: $100/$1,500 × $315 = 21 Foreign tax imposed (withholding tax) $10 Foreign tax credit allowed General category: Lesser of $105 or $150 = $105 Passive category: Lesser of $21 or $10 = 10 Total foreign tax credit = $115 Excess foreign tax credit ($160 - $115) = $45

Branch Profits Tax

Recall that a subsidiary is a separate legal entity owned by the parent while a branch is a disregarded entity for tax purposes. Dividends paid from a US subsidiary to its foreign parent incurs at-source withholding while a branch's earnings remitted to the *foreign corporation* are subject to a branch profits tax.

Don Dealer ("Dealer") is a citizen of the United Kingdom. He decides to come to the United States to open a car dealership in Detroit. Dealer does not obtain a Green Card, but he procures a visa to work in the United States. He is physically present in the United States during the following periods: 20X1 (May 1 through August 30) 20X2 (August 1 through December 30) a) How is Dealer classified in 20X2? Choose the correct classification and explain why it is correct.

Present in 20X2: 31 + 30 + 31 + 30 + 30 = 152 Present in 20X1 : (31 + 30 + 31 + 30)/3 = 40.67 Total present = 192.67 Dealer is a resident alien under the substantial presence test

Sec. 902 indirect credit

Prior to 2018, § 902 provided an indirect credit for US corporate taxpayers who received actual or constructive dividends (e.g., Subpart F income) from a foreign corporation. Beginning in 2018, US C corporations can deduct foreign dividends received via a participation exemption. The § 902 indirect credit (deemed paid credit) remains available for US corporate taxpayers who receive constructive dividends (e.g., Subpart F income) from a foreign corporation.

Taxes that do not qualify for the foreign tax credit

Property taxes, Sales/use tax, VAT (value added tax), Customs tax, Excise tax

Participation Exemption

Qualified dividend received by US corporations from foreign corporations exempt

How are deductions sourced?

Reg. § 1.861-8 provides the general rules for allocating and apportioning deductions to US and foreign source income. Matching of expenses to income takes place based on the factual relationship of the deduction to the gross income.

Foreign Base Company Income § 954: Foreign personal holding company income Active Conduct of Trade or Business Exception

Rents or royalties income from CFC's active conduct of a trade or business with an *unrelated person*. §§954(d)(3)-954(c)(2)(A). (e.g., aircraft rental)

Rick Rocker, a citizen and resident of country F, conducts a three-concert tour in the United States. A multi-talented individual, Rocker sells tickets to his concert from the ticket booth before his concert begins. During intermission, he sells beverages from the concession stand. Afterwards, Rocker sells T‑shirts at the concession stand. Is Rocker engaged in a U.S. trade or business? Explain. If Rocker is engaged in a U.S. trade or business, what income is subject to U.S. tax? When does Rocker pay any U.S. tax?

Rick Rocker has a U.S. trade or business because his activities are considerable, continuous, and regular. Rocker has multiple streams of effectively connected income on which he must report and pay tax on a Form 1040NR at the end of the year. However, his compensation for performing the services of rock concerts also constitutes fixed, determinable, annual, or periodic income that purchasers of tickets must withhold at a 30% rate. The effectively connected income Rocker earns from selling concessions is not fixed, determinable, annual, or periodic income so purchasers of those inventory items do not have to withhold. When filing his Form 1040NR, Rocker can use the withholding on ticket sales as a pre-payment credit against his U.S. tax liability.

Robert is a citizen of Germany. He decides to come to the United States to open a car dealership in Chicago. Robert does not obtain a Green Card but procures a visa to work in the United States. He is physically present in the United States during the following periods: 20X1 (April 1 through July 30) 20X2 (June 1 through August 15) b) How will the US tax Robert's income in 20X2? Choose the correct answer and explain why it is correct.

Robert is taxed on only his U.S.-source income because he is not a US person ECI taxed at net amounts at graduated rates

foreign subsidiary: legal structure

Separate legal entity Insolates the parent from liabilities

method of sourcing: Income from the sale of inventory purchased for resale ("buy it")

Sourced on where sale occurs/title passes

How is income sourced inside the US?

Sourcing rules found in sections 861-865 and tells us our sources within the US

Spartan Corporation, a U.S. corporation, reported $2 million of pretax income from its business operations in Spartania, which were conducted through a foreign branch. Spartania taxes branch income at 15 percent, and the United States taxes corporate income at 21 percent. b. Assume the United States allows U.S. corporations to exclude foreign source income from U.S. taxation. What would be the total tax on the $2 million of branch profits?

Spartania tax ($2,000,000 × 15%) = $300,000 U.S. tax ($0 × 21%) = 0 Total tax = $300,000

Spartan Corporation, a U.S. corporation, reported $2 million of pretax income from its business operations in Spartania, which were conducted through a foreign branch. Spartania taxes branch income at 15 percent, and the United States taxes corporate income at 21 percent. c. Assume the United States allows U.S. corporations to claim a deduction for foreign income taxes. What would be the total tax on the $2 million of branch profits?

Spartania tax ($2,000,000 × 15%) = $300,000 U.S. tax ([$2,000,000 - 300,000] × 21%) = 357,000 Total tax = $657,000

Spartan Corporation, a U.S. corporation, reported $2 million of pretax income from its business operations in Spartania, which were conducted through a foreign branch. Spartania taxes branch income at 15 percent, and the United States taxes corporate income at 21 percent. d. Assume the United States allows U.S. corporations to claim a credit for foreign income taxes paid on foreign source income. What would be the total tax on the $2 million of branch profits? What would be your answer if Spartania taxed branch profits at 30 percent?

Spartania tax ($2,000,000 × 15%) = $300,000 U.S. tax ([$2,000,000 × 21%] - $300,000] = 120,000 Total tax = $420,000 If Spartania taxed branch profits at 30 percent, the United States would allow the foreign tax to reduce the U.S. tax to zero, but the excess $180,000 would become a carryback or carryforward to a prior or future years. Spartania tax ($2,000,000 × 30%) = $600,000 U.S. tax ([$2,000,000 × 21%] - $600,000] = 0 Total tax = $600,000

Spartan Corporation, a U.S. corporation, reported $2 million of pretax income from its business operations in Spartania, which were conducted through a foreign branch. Spartania taxes branch income at 15 percent, and the United States taxes corporate income at 21 percent. a. If the United States provided no mechanism for mitigating double taxation, what would be the total tax (U.S. and foreign) on the $2 million of branch profits?

Spartania tax ($2,000,000 × 15%) = $300,000 U.S. tax ($2,000,000 × 21%) = 420,000 Total tax = $720,000

Calculation of Subpart F Income

Step 1: Determine Potential Subpart F Gross Income Step 2: Apply De Minimis and Full Inclusion rules under §954(b)(3) Step 3: Allocate and Apportion Expenses under §954(b)(5) Step 4: Apply High Tax Exception - §954(b)(4) Step 5: Limitation: Limited to current earnings & profits - §952(c)(1)(A)

What Subchapter of the IRC are international taxation laws found?

Subchapter N

Foreign tax credit

Take credit in amount of foreign tax paid limited to amount that taxpayer would pay in US

What is cross-crediting?

Taking excess credits in one country and offsetting excess limitations of another country. Can do this between countries, but not between baskets of income.

Sombrero Corporation, a U.S. corporation, operates through a branch in Espania. Management projects that the company's pretax income in the next taxable year will be $100,000: $80,000 from U.S. operations and $20,000 from the Espania branch. Espania taxes corporate income at a rate of 30 percent. a. If management's projections are accurate, what will be Sombrero's excess foreign tax credit in the next taxable year? Assume all of the income is foreign branch income.

Taxable income $100,000 × 21% = Precredit U.S. tax $ 21,000 Foreign tax ($20,000 × 30%) = $6,000 FTC limitation: $20,000 / $100,000 × $21,000 = 4,200 Excess FTC $1,800

foreign subsidiary: host country taxation

Taxed by the foreign country because they have permanent establishment

foreign branch: host country taxation

Taxed by the host country because they have permanent establishment

How is a US shareholder taxed under § 956?

Taxed on their ratable share of CFC's investment in US property. Subtract previously taxed investment in US property. Limited to earnings and profits. Absent § 956, a CFC could lend cash or invest in US property without making an actual distribution to a US shareholder, e.g. CFC makes loan to US shareholder (including guarantees), CFC purchases stock issued by US shareholder, CFC builds factory located in US. not as much of a big deal because of the participation exemption; can distribute dividends to shareholders and participation exemption allows them to be tax-free

How does the US tax "fixed, determinable, annual, or periodic income"?

Taxed via withholding at a 30% withholding rate on gross income. (can be reduced through tax treaties)

Why does the United States use a "basket" approach in the foreign tax credit limitation computation?

The "basket" approach limits foreign tax credit blending opportunities (high-tax foreign source income and low -tax foreign source income) to income that is of the same character. Currently, there are four primary categories of FTC income: passive category income, general category income, foreign branch company income, and global intangible low-taxed income (GILTI).

Norman Ray Allen, a nonresident alien, owns 5% of USAco, a U.S. corporation. USAco pays Norman a $1,000 dividend during the current year. Norman also purchases a bond issued by USAco and receives a $1,000 payment. Are there any U.S. withholding requirements with respect to these interest and dividend payments?

The $1,000 dividend is an item of fixed, determinable, annual, or periodic income and, therefore, is subject to U.S. withholding tax at a 30% rate for $300. Although the $1,000 interest payment is also fixed, determinable, annual, or periodic income, the interest is not subject to U.S. withholding tax pursuant to the portfolio interest exception. The portfolio interest exception is available to foreign persons who do not own 10% or more of the shares of the payer and are receiving interest on debt in which there is some kind of assurance that U.S. persons will never own the debt.

Cholati is a foreign corporation that produces fine chocolates for sale worldwide. Cholati markets it chocolates in the United States through a U.S. limited liability company that is treated as a disregarded entity for U.S. tax purposes. The hybrid branch operates a sales office located in New York City. During the current year, Cholati's effectively connected earnings and profits are $3 million, and its U.S. net equity is $6 million at the beginning of the year, and $4 million at the end of the year. Compute Cholati's branch profits tax. Assume that Cholati does not reside in a treaty country.

The branch profits tax imposes a tax equal to 30% of a foreign corporation's dividend equivalent amount for the taxable year, subject to treaty reductions. A foreign corporation's dividend equivalent amount for a taxable year equals the foreign corporation's effectively connected earnings and profits for the taxable year, reduced by the amount of any increase in U.S. net equity for the year (but not below zero), and increased by the amount of any reduction in U.S. net equity for the year (Code Sec. 884). In the present fact situation, Cholati's dividend equivalent amount is $1 million, computed as follows: (A) Effectively connected earnings and profits $3 million (B) Decrease in U.S. net equity: Beginning of the year U.S. net equity $6 million End of the year U.S. net equity $4 million Decrease in U.S. net equity + $2 million Dividend equivalent amount [A + B] $5 million Given that no treaty reductions apply, Cholati's branch profits tax is $1.5 million [$5 million × 30% statutory withholding rate].

What is nexus?

The criteria that jurisdictions use to assert the right to tax a person or transaction

What role does the foreign tax credit limitation play in U.S. tax policy?

The foreign tax credit limitation is designed to limit the credit allowed for foreign income taxes paid or accrued to the amount of U.S. income tax that would have been paid on the income if it was earned in the U.S.

USCo manufactures and markets electrical components. USCo operates outside the US through a number of CFCs, each of which is organized in a different country. These CFCs derived the following income for the current year. Determine the amount of income that USCo must report as a deemed dividend under subpart F in each scenario. a) F1 has gross income of $5 million, including $200,000 of foreign personal holding company income and $4.8 million of gross income from the sale of inventory that F1 manufactured at a factory located within its home country.

The gross income from sale of inventory is not foreign base company sales income because it was produced in the CFC's country of incorporation. The $200,000 of interest income is FPHC income. Under the de minimis rule of §954(b)(3)(A), the interest income is not treated as subpart F income if it is (1) less than $1 million and (2) less than 5 percent of gross income. The interest is less than $1 million and is less than 5 percent of gross income ($200,000/$5,000,000 = 4%). The interest income is not treated as subpart F income in this case.

Falmouth Kettle Company, a U.S. corporation, sells its products in the United States and Europe. During the current year, selling, general, and administrative (SG&A) expenses included: Personnel department $500 Training department 350 President's salary 400 Sales manager's salary 200 Other general and administrative 550 Total SG&A expenses $2,000 Falmouth had $12,000 of gross sales to U.S. customers and $3,000 of gross sales to European customers. Gross income (sales minus cost of goods sold) from domestic sales was $3,000 and gross profit from foreign sales was $1,000. Apportion Falmouth's SG&A expenses to foreign source income using the following methods: c. If Falmouth wants to maximize its foreign tax credit limitation, which method produces the better outcome?

The gross sales method apportions the smaller amount of deductions to the numerator of Falmouth's foreign tax credit limitation formula. As a result, the foreign tax credit limitation ratio will be greater under the gross sales method, and the company's foreign tax credit will be higher.

USCo manufactures and markets electrical components. USCo operates outside the US through a number of CFCs, each of which is organized in a different country. These CFCs derived the following income for the current year. Determine the amount of income that USCo must report as a deemed dividend under subpart F in each scenario. b) F2 has gross income of $5 million, including $4 million of foreign personal holding company interest and $1 million of gross income from the sale of inventory that F2 manufactured at a factory located within its home country.

The interest income is foreign personal holding company income. The gross income from sale of inventory is not foreign base company sales income because F2 produced the inventory in its country of incorporation. Under the full inclusion rule of §954(b)(3)(B), all gross income is subpart F income if gross subpart F income is more than 70 percent of total gross income. F2's subpart F income ($4 million) is 80 percent of total gross income. Therefore, F2's entire gross income ($5 million) is subpart F income.

Cholati is a foreign corporation that produces white chocolates for sale worldwide. Cholati markets its white chocolates in the United States through a U.S. subsidiary. A review of the U.S. subsidiary's interest expense account indicates that it paid $500,000 of interest to an unrelated foreign corporation on debt that is unassignable and $160,000 of interest to a U.S. corporation. What are the withholding obligations of the U.S. subsidiary?

There are three items of fixed, determinable, annual, or periodic income to analyze with respect to any withholding obligations of the U.S. subsidiary. First, the $500,000 of interest to an unrelated foreign corporation on debt that is unassignable is exempt from U.S. withholding tax pursuant to the portfolio-interest exception. Second, the $160,000 of interest paid to a U.S. corporation is not fixed, determinable, annual, or periodic income because it is paid to a U.S. person.

What is the purpose of the foreign tax credit?

To alleviate the impact of double taxation.

How does a taxpayer "take" the foreign tax credit?

To claim the credit, file Form 1118 with a corporate tax return or Form 1116 with an individual tax return.

To foreign source income: $1,000/$4,000 × $2,000 = $500 To U.S. source income: $3,000/$4,000 × $2,000 = $1,500

To foreign source income: $3,000/$15,000 × $2,000 = $400 To U.S. source income: $12,000/$15,000 × $2,000 = $1,600

James Brown, Inc. (JBI), a domestic corporation with operations in Canada, has the following items in 2020: Transaction 1. Total taxable income for the tax year of $550,000 2. $150,000 branch net income in Canada with taxes paid to Canada of $60,000 3. $4,250 payment* received for interest from Royal Bank of Canada (RBC) *RBC withheld $750 in at-source withholding Determine JBI's US net tax liability and any unused foreign taxes.

Total US tax liability: $550,000 x 21% = $115,500 Foreign: $115,500 x (150/550) = $31,500 $60,000 paid take lesser of 2 Passive: $115,500 x (5/550) = $1,050 $750 paid take lesser of 2 $115,500 (31,500) (750) = $83,250 US net tax liability passive has an excess limitation of $300 foreign has an excess credit of $28,500

Carol receives $500 of dividend income from Microsoft, Inc., a U.S. company. True or False: Absent any treaty provisions, Carol will be subject to U.S. tax on the dividend regardless of whether she is a resident or nonresident. Explain.

True. Carol will be taxed on all of her income if she is a U.S. resident. If she is a nonresident, she will be taxed only on her U.S. source income. Because Microsoft, Inc. is a U.S. corporation, the dividend will be treated as U.S. source income and will be subject to (withholding) tax if paid to a non-U.S. citizen or resident.

True or False: A taxpayer will always prefer deducting an expense against U.S. source income and not foreign source income when filing a tax return in the United States. Explain.

True. The deduction reduces taxable income in either case. By apportioning the expense to U.S. source income, the taxpayer maximizes the numerator of the foreign tax credit limitation and, by so doing, maximizes the foreign tax credit. A taxpayer may want to create a deduction in a foreign tax jurisdiction if the tax rate is higher than the U.S. rate.

What income is NOT eligible for the participation exemption?

U.S source income and hybrid dividends (deductible payment in foreign country but a dividend in the US).

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 do countries combat double taxation?

US (unilateral legislation): foreign tax credit foreign earned income exclusion; participation exemption Bilateral legislation: tax treaties

French Bank deposits $20 million in US Bank. French Banks earns $600,000 during 2020. What withholding, if any, will apply to the interest payment in the following situations: 1) French Bank fails to complete Form 8966 FATCA Report.

US bank required to withhold 30% on $600,000. (FATCA)

who can claim the foreign tax credit?

US citizens, resident aliens and domestic corporations can claim the credit. Partners in a partnership (and shareholders in S Corporations) can claim the credit as well. NRAs and foreign corporations can claim the credit on their US ECI trade/business income

How does the US tax foreign activities of US persons?

US citizens/US corporation (also US persons): taxed on *worldwide* income

US shareholder

US person who owns at least 10% of the foreign corporation's total combined voting power or stock value.

Robert Sweets, a US citizen, lives in Burlington, VT, which is close to the Canadian border and a short two-hour drive to Montreal. Robert works for Cupcake Bakery in Burlington and drives to Montreal each week to check in with vendors and customers. The following information relates to Robert's 2019 activity. Determine whether the income is foreign-source or US source. All amounts are US dollars. 4. During 2019, for Cupcake Bakery, Robert drove 120 days from Burlington to Montreal and back to Burlington, spending a total of 240 hours in Montreal. Sweets earned $50,000, working 1,920 hours in 2019.

US source: $50,000 * (1680/1920) = $43,750 Foreign source: $50,000 * (240/1920) = $6,250

Robert Sweets, a US citizen, lives in Burlington, VT, which is close to the Canadian border and a short two-hour drive to Montreal. Robert works for Cupcake Bakery in Burlington and drives to Montreal each week to check in with vendors and customers. The following information relates to Robert's 2019 activity. Determine whether the income is foreign-source or US source. All amounts are US dollars. 2. Robert receives $300 in dividends from Canadian National Railway (CNR), a Canadian corporation. For the past three years, CNR's effectively connected US income has been 33%. Robert also receives $600 from the Coca-Cola Company (CCC), a domestic corporation. For the past three years, CCC's effectively connected US income has been 45%.

US source: $99 of Canadian dividend and $600 of CCC dividend (b/c domestic corporation) Foreign source: $201 of Canadian dividend

How is a US-based subsidiary taxed for US purposes? How are distributions to its owner taxed?

US sub is taxed on worldwide income; distributions subject to FDAP withholdings @ 30%

Della, Inc., a domestic corporation with a manufacturing facility in Mexico, has the following items in 2020: Transaction Total taxable income for the tax year of $750,000 1. $350,000 in taxable income from sales attributable to foreign sources with $105,000 in taxes paid to foreign jurisdictions 2. $8,500 payment* received for dividends from Nestle S.A. (a Swiss corporation) *Nestle withheld $1,500 in at-source withholding Determine Della's US net tax liability and any unused foreign taxes.

US tax prior to credit: $750,000 * .21 = $157,500 Tax after credit: $157,500 less $73,500 less $1,500 = $82,500 General Basket: FTCL: $157,500 * ($350,000/$750,000) = $73,500 or $105,000 taxes paid ($31,500 is unused) Passive Basket: FTCL: $157,500 * ($10,000/$750,000) = $2,100 or $1,500 taxes paid; no unused foreign taxes

Why are income sourcing rules important?

US taxpayers want high foreign source gross income and lower foreign source deductions. Non-US taxpayers are taxed only on US source income and would like to minimize their US source income through higher US deductions.

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.

Under the original fact situation, Quantco has $1 million of excess credits computed as follows: Chinese income taxes [$20 million × 26%] $5.2 million Foreign branch income limitation: (A) Total taxable income............................................................. $100 million (B) Pre-credit U.S. tax [$100 million × 21%]....................................... $21 million (C) Foreign-source taxable income.................................................. $20 million Limitation = [line B × (C ÷ A)] = [$21 million × ($20 million ÷ $100 million)]................................... − $4.2million Excess foreign tax credits...................................................................................... $1 million

Scenario 1 Quantco, a domestic corporation, is an engineering consulting firm that has its main offices in San Diego, California and a branch office in Beijing. During the current year, Quantco generates a total pre-tax profit of $100 million (all from active business operations), including $80 million of profits from its U.S. operations and $20 million of profits from its foreign branch in China. Assume the U.S. tax rate is 21% and the Chinese rate is 26%. Compute Quantco's creditable foreign income taxes, foreign tax credit limitation, and excess credits (if any). Scenario 2 Now assume that Quantco has a second foreign branch office in Singapore which generated $10 million of profits (all from active business operations), on which Quantco pays Singapore taxes. Assume the effective Singapore tax rate is 8%. Recompute Quantco's creditable foreign income taxes, foreign tax credit limitation, and excess credits. What is the name of the phenomenon by which the Singapore profits resulted in the elimination of the excess credits on the Chinese profits?

Under the revised facts, because both the Singapore and the Chinese profits are assigned to the foreign branch income limitation, the $10 million of low-tax Singapore profits will completely eliminate Quantco's excess credits, as follows: Foreign income taxes [($20 million × 26%) + ($10 million × 8%)]..................................... $6 million Foreign branch income limitation: (A) Total taxable income [$100 million + $10 million]......................... $110 million (B) Pre-credit U.S. tax [$110 million × 21%].................................... $23.1 million (C) Foreign-source taxable income.................................................. $30 million Limitation = [line B × (C ÷ A)] = [$23.1 million × ($30 million ÷ $110 million)]............................... − $6.3 million Excess foreign tax credits............................................................................................ None Quantco no longer has any excess credits because the average rate of foreign tax is now 20% (foreign taxes of $6 million ÷ $30 million of foreign income), which is lower than the U.S. tax rate of 21%. The process by which the excess limitation on the low-tax Singapore profits is credited against (or soaks up) the excess credits on the high-tax Chinese profits is known as "cross-crediting."

foreign branch: legal structure

Unincorporated office; not a separate legal entity 100% owned by the US corporation one owner only

When are unused foreign taxes used?

Unused foreign taxes are used when FTC limitation exceeds the foreign tax attributable to that tax year. This produces an excess foreign tax credit limitation. Carryovers are applied on a FIFO basis, with the current year FTC being used first

accrual method: translation of taking credit for foreign taxes paid

Use an average annual exchange rate

Waco Leather, Inc., a U.S. corporation, reported total taxable income of $5 million. Taxable income included 1.5 million of foreign source taxable income from the company's branch operations in Mexico. All of the branch income is foreign branch income. Waco paid Mexican income taxes of $300,000 on its branch income. Compute Waco's allowable foreign tax credit.

Waco's precredit U.S. tax is $1,050,000 ($5,000,000 × 21%). The company's foreign tax credit limitation is computed as: $1,500,000 / $5,000,000 × $1,050,000 = $315,000. Waco's allowable foreign tax credit is the full $300,000. Waco has an "excess foreign tax credit limitation" of $15,000, which can absorb foreign tax credit carryforwards from prior years.

What are the criteria to "check the box"?

We must be a separate legal entity, must be a business entity and not a trust, and must be an eligible entity.

Identify whether the corporations described below are controlled foreign corporations. a) Shetland PLC, a UK corporation, has two classes of stock outstanding, 75 shares of class AA stock and 25 shares of class A stock. Each class of stock has equal voting power and value. Angus owns 35 shares of class AA stock and 20 shares of class A stock. Angus is a US citizen who resides in England.

Yes. Angus is a "U.S. shareholder" because he owns 10 percent-or-more of the total combined voting power or value of Shetland PLC assuming each share of stock has the same voting power and value: 35/75 Class AA stock = 46.6% × 75/100 = 35% total voting power and value 20/25 Class A stock = 80% × 25/100 = 20% total voting power and value Combined voting power and value = 55% Shetland PLC is a CFC because the U.S. shareholder (Angus) owns more than 50 percent of the total voting power or value of its stock. Angus would be required to include in his income currently 55 percent of the corporation's subpart F income.

USCo owns 100 percent of the following corporations: Dutch NV, Germany AG, Australia PLC, Japan Corporation, and Brazil SA. During the year, the following transactions took place. Determine whether the transaction results in subpart F income to USCo. b) Dutch NV leased office machines to unrelated persons. Dutch NV performed only incidental activities and incurred nominal expenses in leasing and servicing the machines. Dutch NV is not engaged in the manufacture or production of the machines and does not add substantial value to the machines.

Yes. Dutch N.V. would not be engaged in an active trade or business because the CFC did not add substantial value to the machines. The rental income would be foreign personal holding company income.

Identify whether the corporations described below are controlled foreign corporations. c) Pierre, a US citizen, owns 45 of the 100 shares outstanding in Vino S.A., a French corporation. Pierre's father, Pepe, owns 8 shares in Vino. Pepe also in a US citizen. The remaining 47 shares are owned by non-US individuals.

Yes. Pierre and Pepe meet the test to be U.S. shareholders: direct ownership constructive ownership total Pierre 45% 8% 53% Pepe 8% 45% 53% Pierre is deemed to own the shares owned by his parent under the constructive ownership rules of §958(b). Pepe is deemed to own the shares owned by his son under the constructive ownership rules of §958(b). The corporation is a CFC because the ownership of Pierre or Pepe is greater than 50 percent of voting power or value. Pierre includes in his income currently 45 percent of Vino's subpart F income. Pepe includes in his income currently 8 percent of Vino's subpart F income. (The constructive ownership rules only apply to determine if the corporation is a CFC and a U.S. person is a U.S. shareholder).

USCo owns 100 percent of the following corporations: Dutch NV, Germany AG, Australia PLC, Japan Corporation, and Brazil SA. During the year, the following transactions took place. Determine whether the transaction results in subpart F income to USCo. c) Dutch NV purchased goods manufactured in France from an unrelated contract manufacturer and sold them to Germany AG for consumption in Germany.

Yes. The income from sales to German A.G. would be foreign base company sales income because the goods were purchased from an unrelated person outside the CFC's country of incorporation and sold to a related person for consumption outside the CFC's country of incorporation.

Identify whether the corporations described below are controlled foreign corporations. b) Tony and Gina, both US citizens, own 5 percent and 10 percent, respectively, of the voting stock and value of DaVinci S.A., an Italian corporation. Tony and Gina are also equal partners in Roma Corporation, an Italian corporation that owns 50 percent of the DaVinci stock.

Yes. Tony and Gina are U.S. shareholders because they each meet the 10 percent of voting power and value test: Direct Ownership Constructive Ownership Total Tony 5% 25% 30% Gina 10% 25% 35% Tony and Gina each own their pro rata share of the DaVinci stock owned by the Roma Corporation under §958(b). DaVinci S.A. is a CFC because the U.S. shareholders collectively own more than 50 percent of the value or voting power of its stock. Tony includes 30% of DaVinci's subpart F income in income currently, and Gina includes 35% of DaVinci's subpart F income.

US person

a US citizen, resident alien, a domestic corporation, a domestic partnership and domestic trust or estate.

Foreign-Derived Intangible Income (FDII)

a deduction, not an income inclusion like GILTI; does not involve a CFC like GILTI The FDII deduction incentivizes *C corporations* to keep their intangibles in the US by decreasing the tax rate on this income through a deduction. Beginning in 2018, C corporations are eligible to deduct 37.5% of its FDII. Via the deduction, FDII is effectively taxed at 13.125% FDII = (Total DE Income * - 10% adjusted basis of assets**) X (foreign derived DE income***/total DE income) DE: deduction eligible *gross income (excludes GILTI, Subpart F, and foreign branch income) less allocable deductions ** quarterly average of depreciable assets used in trade/business to generate DE income *** derived in connection with property sold/licensed/leased to a non-US person for use outside the US OR services provided to a person located outside the US

hybrid entity

a foreign business entity that is treated as a corporation for foreign tax purposes but as a disregarded entity (branch) or partnership for US tax purposes. The US Treasury allows eligible entities to elect their US tax status by "checking the box" on Form 8832 Entity Classification Election.

controlled foreign corporation (CFC)

a foreign corporation in which more than 50% of the combined voting power of all classes of stock OR more than 50% of the value of all stock is owned by US shareholders on any day of the corporation's tax year.

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.

Petoskey Stone, Inc., a U.S. corporation, received the following sources of income during the current year. Identify the source of each item as either U.S. or foreign. a. Interest income from a loan to its German subsidiary. b. Dividend income from Granite Corporation, a U.S. corporation. c. Royalty income from its Irish subsidiary for use of a trademark d. Rent income from its Canadian subsidiary of a warehouse located in Wisconsin

a. Foreign source (residence of the payer of interest) b. U.S. source (residence of the payer of the dividend) c. Foreign source (where the intangible is used) d. U.S. source (where the property being rented is located)

What happens if an NRA is considered to have a US trade or business?

all US source income other than FDAP becomes ECI

Foreign Account Tax Compliance Act (FATCA)

an attempt by the US Government to obtain information from foreign entities regarding US persons who are investors in these foreign entities. (Keep in mind that foreign entity earnings such as interest may not be taxable, but US persons are taxed on their worldwide income; thus, US persons should not receive benefit of this reduced taxation.); deterring tax evasion US person (individual) invests in foreign corp/person that invests in US person/corp

Election must be signed by...

an authorized officer of the entity or existing / prior owners

Fisher, Inc., a domestic corporation, generates US source and foreign-source gross income for the current year. Fisher's assets (tax book value) are as follows: Assets generating US-source income $18,000,000 Assets generating foreign-source income 5,000,000 Total assets $23,000,000 Fisher incurs interest expense of $800,000 for the current year. How is interest expense apportioned?

assume that the $18M and $5M are already out average tax book values apportion between US & foreign $800,000 x (5/23) = $173,913 foreign source deduction

Sec. 901 direct credit

available for *income tax* paid by US taxpayer; taxpayer must have legal responsibility to pay tax

FireCo (a US corporation) has taxable income in 2020 of $22 million. During the year, FireCo made deductible rent payments of $28 million to its wholly owned foreign corporation ExhumaCo. FireCo also purchased $10 million of inventory from ExhumaCo. FireCo's annual gross receipts for the prior three years are: $475 million (2017), $580 million (2018), and $490 million (2019). Calculate FireCo's 2020 BEAT liability. Assume total deductions of $522M. BEAT rate for 2020 is 10%.

average gross receipts = ($475M + $580M + $490M)/3 = $515M > $500M $28M deductible payments/$522M total deductions = 5.3% > 3% BEAT applies BEAT = (BEAT rate X modified taxable income) less the regular US corporate income tax modified taxable income = taxable income + base erosion payments $22M x 21% = $4.62M corp. tax liability $22M + $28M = $50M x 10% BEAT rate = $5M - $4.62M = $380,000 BEAT

When is FATCA withholding triggered?

comes into play when US person/corp makes payment to foreign corp/person. if foreign corp/person has not filed FATCA report for US investors (form 8966), US person/corp is required to withhold on these payments.

If one person owns 100% of the entity, then it can be taxed as either a ____ or ____

corporation; branch

If more than one person owns the entity, then it can be taxed as either a ____ or ___

corporation; partnership

home country

country a taxpayer is a citizen of

host country

country where taxpayer is living abroad

What is the central problem of international taxation?

double-taxation; home country and host country tax same transaction

What happens to unused foreign taxes, i.e., limited by the Foreign Tax Credit Limitation?

excess creditable foreign taxes paid (NOT excess foreign tax credit limitation) are eligible for carryback and carryforward. Carryback period is 1 year, and carryforward period is 10 years Unused foreign taxes can only be used in future (or previous year) years within the same income basket Must be credited; can't be deducted in c/f or c/b years

Interest income earned by foreign persons: method of taxation

exempt from taxation

Portfolio interest on obligations issued by a US person: method of taxation

exempt from taxation

Reverse hybrid entities

foreign entities that are treated as corporations for US tax purposes but as partnerships for foreign tax purposes

Cupcake Bakery, a US corporation, makes cupcakes at its US manufacturing facility near Burlington, VT. The following information relates to Cupcake's 2019 activity. Determine whether the income is foreign-source or US source. All amounts are US dollars. 2. Cupcake issues a license to Lemco (an Irish company) for the use of cupcake design software in France.

foreign source

Cupcake Bakery, a US corporation, makes cupcakes at its US manufacturing facility near Burlington, VT. The following information relates to Cupcake's 2019 activity. Determine whether the income is foreign-source or US source. All amounts are US dollars. 3. Cupcake purchases cupcake forms from a manufacturer in Mexico. Cupcake then sells the cupcake forms to DanzeCo. (a Brazilian company) with title passing in Argentina.

foreign source b/c title passes in Argentina

Income from sale of personal property: method of taxation

generally exempt from withholding unless FATCA applies

Sec. 482 Allocation of income and deductions among taxpayers

in any case of two of more organizations, trades, or businesses owned or controlled directly or indirectly by the same interest, the Secretary may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such organizations, trades, or businesses if he determines it is necessary to prevent evasion of taxes or clearly reflect the income of these organizations, trades, or businesses

Ingrid, an NRA, operates a US business. During the year, cash funds accumulate. Ingrid invests these funds on a short-term basis so that they remain available to meet her business needs. How is the income from the investments classified?

interest income is typically income; it is generated for her business. invested short-term to put it back into her business. will be taxed as ECI

Foreign Base Company Income § 954: Foreign personal holding company income

investment/passive income; includes dividends, interest, royalties, rents, and annuities; Net gains from the sale/ exchange of property that produces FPHC income, net gains from commodities and foreign currency

What are the general criteria for determining if a US trade or business exists?

looking for the location of management, distribution activities, production activities, etc to be continuous, regular, and substantial; use facts and circumstances

On January 1, 2018 Santiago Corporation (a US C corporation) purchased 12% of Peralta Corporation (a foreign corporation located in Country X). Assume Peralta's 2019 income is $5 million. Country X's tax rate is 15%, while the US tax rate is 21%. Country X has no dividend withholding tax. On December 31, 2019 Peralta distributes its current year after-tax earnings to its shareholders in proportion to stock ownership. Assume they have not sold the stock. Determine the 2019 tax impacts to Santiago.

meets participation exemption requirements; >10% of stock, holding period of >366 days, not hybrid dividend, is foreign source income. $5M x 15% = $750,000 Country X tax $5M - $750,000 taxes paid = $4.25M x 12% share = $510,000 distribution; THIS IS OUR DIVIDEND INCOME; no gross-up report $510,000 of dividends and take $510,000 of Sec. 245A deduction (participation exemption); $0 taxable income NOT eligible for foreign tax credit

Joan, a US citizen, is considering expanding her retail business (a C corporation) into Canada. Joan has a plan to take orders from her Detroit showroom and have the goods delivered by an independent delivery service. Will this create a permanent establishment in Canada? What if Joan maintained a storage facility in Canada in addition to the sales referenced above?

Joan, a US citizen, is considering expanding her retail business (a C corporation) into Canada. Joan has a plan to take orders from her Detroit showroom and have the goods delivered by an independent delivery service. Will this create a permanent establishment in Canada? What is Joan decided to engage the services of an independent broker in Canada to sell her goods but is not given the right to conclude contracts on behalf of Joan?

On January 1, 2018 Holt Corporation (a US C corporation) formed Cheddar Corporation (a foreign corporation located in Country B). Assume Cheddar's 2019 income is $20 million. Cheddar pays a dividend of $20 million to Holt. This payment is treated as an interest payment in Country B. Country B's tax rate is 30%, while the US tax rate is 21%. Determine the 2019 tax impacts to Holt.

not eligible for participation exemption because it is a hybrid dividend; subject to tax at 21% in US but eligible for deduction in Country B (tax rate 30%)

What are some important compliance rules to keep in mind?

o Can election on an annual basis whether to claim the credit or deduct the taxes paid o The election applies to all foreign income taxes paid for the year o Have 10 years to make or change election

form 8832 change of election

o Change of election is binding for 60 months (for all but initial election) - Reg. §301.7701-(c)

Sam Smith is a citizen and bona fide resident of Great Britain (United Kingdom). During the current year, Sam received the following income: o Compensation of $30 million from performing concerts in the United States o Cash dividends of $10,000 from a French corporation's stock o Interest of $6,000 on a U.S. corporation bond. o Interest of $2,000 on a loan made to a U.S. citizen residing in Australia o Gain of $80,000 on the sale of stock in a U.S. corporation. Determine the source (U.S. or foreign) of each item of income Sam received.

o Compensation of $30 million from performing concerts in the United States: U.S. source - based on where the event took place o Cash dividends of $10,000 from a French corporation's stock: Foreign source - based on residence of the payer o Interest of $6,000 on a U.S. corporation bond.: U.S. source - based on residence of the payer o Interest of $2,000 on a loan made to a U.S. citizen residing in Australia: Foreign source - based on residence of the payer o Gain of $80,000 on the sale of stock in a U.S. corporation: Foreign source - based on residence of the seller

Foreign Base Company Income § 954: Foreign personal holding company income Same Country Exceptions

o §954(c)(3)(A)(i): Rents and royalties from a *related* corporation for the use of property *within the CFC's country of incorporation* o §954(c)(3)(A)(ii): Dividends and interest from a *related* corporation *incorporated in same country as CFC*.

indirect ownership of stock

own an entity that owns shares in CFC

constructive ownership of stock

own what family owns

direct ownership of stock

own what you personally own

The foreign tax credit limitation is calculated separately for different "baskets" of foreign-source taxable income. For tax years beginning after 12/31/2017, there are four income baskets of foreign-source taxable income:

passive, foreign branch, general and global intangible low-tax income.

permanent establishment includes:

physical presence in the country (factory, workshop, office, branch, place of management), have employees/ contractors/agents who can conclude contracts in country

Subpart F

provide that certain types of income generated by CFCs are subject to taxation in the current year regardless of actual distributions to the parent entity. These certain types of income are "tainted" income. US shareholders who own shares in a CFC on the last day of the CFC's year include in gross income their ratable share of Subpart F income, Investment of Earnings in US Property and Global Intangible Low-Taxed Income (GILTI).

Indirect (Deemed Paid) Taxes § 960

provides an indirect credit for US corporate taxpayers (must own at least 10% of the foreign corporation's voting stock) who receive constructive dividends (e.g., Subpart F income) from a foreign corporation. for CFC calculate foreign taxes paid attributable to constructive dividend indirect FTC = (Constructive dividend before § 78 gross up in foreign currency/Post-1986 undistributed E&P in foreign currency) x Post-1986 foreign taxes in US dollars this is our Sec. 78 gross up; § 78 requires a US corporation to "gross up" the dividend by the amount of the credit. The gross up brings the dividend received up to the pretax income of the subsidiary related to the dividend distributed. [subpart F + Sec. 956 + GILTI] (this is our constructive dividend) + Sec. 78 gross up = income inclusion; apply foreign tax credit limitation & look through rules

permanent establishment

provision under which US exporter's business profits are exempt from tax in the host country unless the profits are attributable to a PE within the host country. The Permanent Establishment (PE) tax treaty concept is similar to "trade or business" but allows more activities without giving rise to an income tax exposure in the jurisdiction. TAX TREATY CONCEPT; if operating in country that does not have US tax treaty, cannot rely on this concept

Treaty reductions for dividends, interest and royalties: method of taxation

reduced to 15%

Best Method Rule

requires the taxpayer to select and apply the method that provides the most reliable estimate of an arm's length price; reliability of a pricing method is determined by the degree of comparability between the controlled and uncontrolled transactions

Patriots, Inc. a domestic corporation, owns 40% of New England, Inc., a controlled foreign corporation. In the current year, New England has $250,000 of Subpart F income taxable to its US shareholders. New England paid foreign taxes of $500,000 on post-1986 E&P. New England's post-1986 E&P $1.2 million. What is Patriots' deemed-paid foreign taxes? What is Patriots' gross income?

subpart F income $250,000 x 40% = $100,000; constructive dividend ($100,000 / $1.2M) x $500,000 = $41,667 deemed-paid foreign taxes $100,000 + $41,667 = $141,667 income inclusion

modified taxable income

taxable income + base erosion payments

Effectively Connected Income (ECI): method of taxation

taxed at marginal tax rates

How is a US-based branch taxed for US purposes?

taxed on US ECI; remittances back to foreign corporation are taxed according to branch profits tax

US-source investment income

taxed on foreign persons Taxed on gross amounts at flat withholding rate of 30%

Effectively connected income (ECI)

taxed on foreign persons Trade or business income; taxed on net income at graduated tax rates

transfer price

the price that related parties use when they sell to each other; does not have to be an international transaction

International taxation

the study of the coordinating the tax authority of sovereign countries

Vinny, an NRA, is a wine distributor. During the current year, Vinny earns $500,000 from exporting wine to unrelated wholesalers in the US, with title passing in New York. Vinny has no offices or employees in the US. How is Vinny taxed on the $500,000 of US source income?

title passes in New York -> US income Vinny is a non-US person; taxed only on US income Not FDAP income; to be ECI, needs to have regular, continuous, and substantial presence within the US; because he has no office or employees, not ECI; Vinny is not taxed on this income by the US

Vinny, an NRA, is a wine distributor. During the current year, Vinny earns $500,000 from exporting wine to unrelated wholesalers in the US, with title passing in New York. Now assume Vinny hires Jake to run a hot dog cart in New York City. How is Vinny taxed on the $500,000 of wine income?

title passes in New York -> US income Vinny is a non-US person; taxed only on US income Not FDAP income; to be ECI, needs to have regular, continuous, and substantial presence within the US; hot dog cart creates trade or business presence within US that is regular, continuous, or substantial; Vinny is now taxed on this $500,000 income by the US

Sec. 250 GILTI deduction

total inclusion amount x 50% ONLY FOR US CORPORATIONS Remember that net GILTI income will be reported in its own foreign tax credit limitation basket with no carryback or carryforward of excess credits.

cash method: translation of taking credit for foreign taxes paid

translate using the exchange rate on date of payment

accrual method: timing of taking credit for foreign taxes paid

when it's incurred & meets "all events test" (liability exists & we know the amount)

cash method: timing of taking credit for foreign taxes paid credit

when paid

Joan, a US citizen, is considering expanding her retail business (a C corporation) into Canada. Joan has a plan to take orders from her Detroit showroom and have the goods delivered by an independent delivery service. Will this create a permanent establishment in Canada? What if the broker were able to conclude contracts for Joan?

yes

The goals of Subpart F are to prevent:

· Deferral of income if income easily could have been earned in the United States o Insurance income § 953 o Foreign base company income § 954 · Deferral if against US policy o International boycott factor income § 999 o Illegal bribes o Income derived from a § 901(j) foreign country (Blacklisted countries) · No deferral on hidden distributions o Investment in US property § 956

effective date of form 8832

· Retroactive 75 days before the election is filed · Effective up to 12 months after the election is filed

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