International Tax Blog

International Aspects of Mitt Romney’s 2010 Tax Return

Mitt Romney’s 2010 tax return had a number of international related items.  First, he has an interest in, or signature authority over, one or more financial accounts in Switzerland.  See Question 7 on Schedule B.  Presumably, he also filed an FBAR for the Swiss account(s).

Second, he had passive gross foreign source income of $1,525,982, with current year foreign income taxes paid on this income of $67,173.  He also had $81,461 of a carryforward of passive foreign taxes from prior years, and he will carry forward $18,397 of passive foreign tax credits to 2011.  He had an alternative minimum tax credit in the passive basket of of $77,565.  See Forms 1116.

Although he had no general category foreign source income for 2010, he paid $690 of foreign taxes in the general category for 2010, and he carried forward $100,010 of foreign tax credits in the general category to 2010.  His carry forward of general category foreign tax credits to 2011 will be $100,700.

Third, he filed Forms 8621 for seventeen passive foreign investment companies ("PFICs").  Four of these forms he made mark-to-market elections.  Ten of the forms made qualified electing fund (“QEF”) elections.  For one of the forms he appears to have made a QEF election in a prior year.  Lastly, two of the forms related to Code §1291 funds.

Fourth, he filed a Form 8865 to reflect that he had contributed $172,109 to a Cayman Islands limited partnership.

Fifth, he filed Form 5471 to disclose his wholly owned Bermuda investment holding company.  The company had a nominal deficit in current earnings during 2010 and reflected previously taxed income from prior Subpart F Income inclusions of $13,366.

Sixth, he filed two Forms 926 to disclose cash contributions to two Irish corporations.  One of the transfers was for $1,523,419 and the other was for $139,625.  Both contributions were non-taxable Code §351 exchanges.

International PLRs of the 3rd week of 2012

Last week the IRS published the following Private Letter Rulings relating to international taxation:

PLR 201203010: A non-self-propelled barge with two cranes affixed to its deck  that was owned by a CFC and used in the construction of offshore platforms in the U.S. Gulf of Mexico did not constitute U.S. property within the meaning of Code §956(c).

PLR 201203004: Spin-off including foreign entities. Code §355.

Uncompensated Use of Foreign Trust Property

As a result of 2010 changes to Code §643(i)(1), the use of foreign trust property by a U.S. grantor, a U.S. beneficiary, or a U.S. person related to the U.S. grantor or the U.S. beneficiary is treated as a distribution of the fair market value of the use of the property to the U.S. grantor or U.S. beneficiary.  The use of the property is not treated as a distribution to the extent that the trust is paid the fair market value for the use of the property within a reasonable period of time.

For example, say a U.S. individual is a beneficiary of a foreign trust that was created by a nonresident alien relative, and the foreign trust owns a family home located outside the U.S.  The family home is available for personal use by the U.S. individual and by other nonresident alien family members.  If the U.S. individual visits the home for a two week vacation, without paying rent for the two weeks, the U.S. individual will be treated as having received a distribution from the foreign trust in an amount equal to the fair market value of the use of the home for the two week period.

This deemed distribution would trigger a requirement to file Form 3520 for that year.  It is important to note that the penalty for failure to timely file Form 3520 is the greater of $10,000 or 35% of the deemed distribution, unless the failure can be shown to be due to reasonable cause and not to willful neglect.

An interesting question would be whether uncompensated use of the foreign home by a nonresident alien relative of the U.S. beneficiary, where the nonresident alien relative was also a beneficiary of the foreign trust, would trigger a deemed distribution and a Form 3520 filing requirement to the U.S. beneficiary.

Income Accruing in Foreign Retirement Plans

U.S. citizens that live and work outside the U.S. often participate in foreign retirement plans.  Similarly, non-U.S. citizens that move to the U.S. and become U.S. tax residents, after working outside the U.S., have often participated in foreign retirement plans.

A question that sometimes arises is whether the income accruing annually in the foreign retirement plans must be included on the individual's U.S. tax return.  The rule for this situation was concisely stated in Rev. Proc 2002-23:

Under the domestic law of the United States, an individual who is a citizen or resident of the United States and a beneficiary of a [foreign] retirement plan will be subject to current United States income taxation on income accrued in the [foreign retirement] plan even though the income is not currently distributed to the beneficiary, unless the plan is an employees’ trust within the meaning of section 402(b) of the Internal Revenue Code and the individual is not a highly compensated employee subject to the rule of section 402(b)(4)(A).

Thus, as long as the foreign retirement plan is an employees’ trust and the individual is not a highly compensated employee, then no inclusion is required.  On the other hand, if the foreign retirement plan is not an employees’ trust or if the individual is a highly compensated employee, then the annual increase in value of the foreign retirement plan is required to be included on the U.S. individual’s U.S. tax return.

There are often special rules in U.S. tax treaties that modify the taxation of pensions or retirement plans.  Consequently, the applicable treaty should always be reviewed to determine whether U.S. domestic law is overridden by treaty.

Forms 3520 and 3520-A are generally not required to be filed by a U.S. individual who is the beneficiary of a foreign retirement that is an employees’ trust.  However, U.S. individuals who are beneficiaries of other types of foreign retirement plans that are characterized as trusts for U.S. tax purposes may need to file Forms 3520 and 3520-A.

In addition, it is important to note that an FBAR and a Form 8938 may be required with respect to an interest in a foreign retirement plan.

New FBAR (Again) - Email Your Questions

The Treasury Department issued a new FBAR in January 2012.  This is the third revision of the form in less than one year.

The instructions to the FBAR (TD F 90-22.1, Report of Foreign Bank and Financial Accounts) were substantially revised in March 2011.  In November 2011, according to Willem Perez, there were two changes to the instructions (relating to the estimated time to complete the form and relating to amended forms).

The latest version of the form appears to only change who to contact if you have questions (page 7).  The old form (from two months ago) indicated that questions should be directed to the Detroit Computing Center Hotline at an 800 number.  Now the form specifies to call 866-270-0733 number for domestic callers and 313-234-6146 for international callers.

The new instructions also include an email address for questions: FBARquestions@irs.gov.  With taxpayers so concerned about FBAR penalties, providing an email address for questions is a step in the right direction.

International PLRs of the 2nd week of 2012

Last week the IRS published the following Private Letter Rulings and Chief Counsel Advice relating to international taxation:

PLR 201202007: Spin-off including foreign entities. Code §355.

PLR 201202011: Permission to make a second entity classification election within 60 months of the first entity classification election was granted. Treas. Reg. §301.7701-3(c)(iv).  Form 8832.  60 month limitation on check-the-box elections.

PLR 201202013: Late entity classification elections for two foreign entities to be treated as partnerships and one foreign entity to be treated as a disregarded entity.  Treas. Reg. §301.7701-3(c) and Treas. Reg. §301.9100-1, -2, and -3.  Form 8832.

PLR 201202015: Late entity classification election where "the Form 8832 * * * was inadvertently not timely filed" for a foreign entity.  Treas. Reg. §301.7701-3(c) and Treas. Reg. §301.9100-1, -2, and -3.  Form 8832.

CCA 201202021: Removing the limitation of deduction for interest under Code §163(j) does not qualify as a change in accounting method under Code §446.

International PLRs of the 1st week of 2012

This week the IRS published the following Private Letter Rulings relating to international taxation:

PLR 201201013: Late/retroactive PFIC QEF election

PLR 201201016: Gain on disposition of assets generating active financing income under Code §954(h) did not trigger Foreign Personal Holding Company Income

International PLRs of the 52nd Week of 2011

This week the IRS published the following Private Letter Rulings relating to international taxation:

PLR 201152007 - Late PFIC mark-to-market election

PLR 201152008 - Spin-Offs by U.S. corporation with foreign parent, with various deemed transfers

PLR 201152012 - Early re-election of 911 exclusion

PLR 201152013 - Late/retroactive passive foreign investment company ("PFIC") qualified electing fund ("QEF") election

PLR 201152015 - Drop of shares of Fsub2 into Newco2 (foreign) followed by a check-the-box election on Fsub2 (to treat Fsub2 as a disregarded entity of Newco2) was treated as an F reorganization, despite the fact that certain post reorganization transactions were treated as distributions.

International PLRs of the 51st Week of 2011

This week the IRS published the following Private Letter Rulings relating to international taxation:

PLR 201151008: Method for determining unearned premiumns and reserves for life insurance contracts in computing qualified insurance income of a controlled foreign corporation under Code §954(i)(4)(B)(ii).

PLR 201151010: Late entity classification election granted where the foreign entity "inadvertently failed to file a Form 8832"

PLR 201151017: Spin-Off with a foreign company that has American Depositary Shares

PLR 201151019: Consent was granted to revoke safe harbor method elections in computing foreign tax credits with respect to a dual capacity taxpayer under Treas. Reg. §1.901-2A(c)(1).

 

Expatriate Graph “Re-Clarified”

For roughly two years, I have been publishing a graph of the number of expatriates listed in the Federal Register (see Expatriation).  Earlier this year I was told that the individuals listed in the Federal Register generally only include individuals that meet the net worth test or the tax liability test under Code §877(a)(2).

I took a quick look at the statute, and I agreed.  Therefore, I wrote a blog post “clarifying” the graph. 

I recently decided to take a more detailed look at the rules when a reader of this blog informed me that his name was included in the Federal Register, even though he did not meet the net worth test or the tax liability test.  It turns out that my "clarification" was wrong.

The Federal Register includes, and therefore the graph includes, all renouncing U.S. citizens and all individuals that have terminated their U.S. lawful permanent residency status for which the I.R.S. has received information from one or more of three different sources.

According to Code §6039G(d), the individuals listed in the Federal Register include:

"[E]ach individual losing United States citizenship (within the meaning of section 877(a) or 877A) with respect to whom the [I.R.S.] receives information under the preceding sentence * * *."

In the “preceding sentence,” there are three sources from which the I.R.S. receives information.  

With respect to the first source, “any Federal agency or court which collects (or is required to collect) the statement under subsection (a) shall provide to the [I.R.S.]” certain information.  The statement under subsection (a) is only required for those individuals that meet the net worth test or the tax liability test (or that fail to certify they have met their U.S. tax filings for 5 preceding years).  

If this first source were the only source from which the I.R.S. were to receive information about individuals expatriating, then the Federal Register would generally only include individuals that meet the net worth test or the tax liability test.  However, there are two other sources from which the I.R.S. receives information about individuals expatriating.

The second source is from the Secretary of State, which is required to provide to the I.R.S. “a copy of each certificate as to the loss of American nationality under section 358 of the Immigration and Nationality Act which is approved by the Secretary of State.”

The third source is from “the Federal agency primarily responsible for administering the immigration laws,” which is required to provide to the I.R.S. “the name of each lawful permanent resident of the United States (within the meaning of section 7701(b)(6)) whose status as such has been revoked or has been administratively or judicially determined to have been abandoned.”

Thus, if the I.R.S. receives information about individuals from the Secretary of State about the loss of U.S. citizenship, or receives information about individuals from the Federal immigration agency about the revocation of lawful permanent residency status, then these individuals’ names will also be included in the Federal Register.  The list in the Federal Register does not only include individuals that meet the net worth test or the tax liability test.

International PLRs of the 50th Week of 2011

This past week the IRS published the following Private Letter Rulings and other written determinations relating to international taxation:

In seventeen PLRs (PLR 201150001 thru 201150017), late entity classification elections were granted for foreign entities “due to inadvertence.”

PLR 201150019:  This lengthy PLR (21 pages) includes a Code §351 exchange, multiple Code §332 liquidations, a Code §368(a)(1)(C) reorganization, and a divisive Code §368(a)(1)(D) reorganization with a Code §355 spin-off.

PLR 201150021: Another lengthy PLR (29 pages) that includes a Code §304 transaction, multiple Code §351 exchanges (including preferred equity certificates, or “PECs”), three acquisitive Code §368(a)(1)(D) reorganizations, and one Code §368(a)(1)(A) merger.

CCA 201150029:  In this chief counsel advice the issue was whether the Code §6677 penalty for failure to file information with respect to foreign trusts under Code §6048 (see Forms 3520 and 3520-A) is a “divisible tax” such that a taxpayer would need to pay only a portion of the penalty to sue for a refund.  The CCA concludes that the penalty is not a “divisible tax” and that a taxpayer must pay the full amount of the penalty to challenge the entire penalty assessment under Code §6677 for a particular year.  However, if a taxpayer chooses only to contest a portion of the penalty relating to one or more particular failures to report, but not all failures, the taxpayer may pay that portion and sue for refund. 

 

 

Code §951 Inclusions Are Not Qualified Dividend Income

On December 7, 2011, the Tax Court published Rodriquez v. Commr., 137 T.C. No. 14 (2011).  In this case, the taxpayers filed tax returns including in gross income, under Code §§951(a)(1)(B) and 956, approximately $1.6 million for 2003 and approximately $1.5 million for 2004.  The inclusions represented their controlled foreign corporation’s earnings invested in U.S. property.

The taxpayers had treated the inclusions as qualified dividend income under Code §1(h)(11).  The I.R.S. argued, and the court held, that the Code §951 inclusions were not qualified dividend income because the inclusions were not dividends.  In Notice 2004-70, the I.R.S. had provided guidance that Code §951 inclusions did not constitute qualified dividend income under Code §1(h)(11), and the court in Rodriquez agreed with this conclusion.

Depending upon the circumstances, it may have made sense for the taxpayers in Rodriquez to make Code §962 elections for 2003 and 2004, where individuals can elect to be subject to tax at corporate rates but at the same time be allowed to claim deemed paid foreign tax credits under Code §960.

International PLRs of the 49th Week of 2011

This week the IRS published the following Private Letter Rulings relating to international taxation:

201149007 - Late entity classification elections for foreign entities

Loan With “Kicker” is a USRPI

Treas. Reg. §1.897-1(c) defines the term “United States real property interest” (“USRPI”) to mean any interest, other than an interest solely as a creditor, in either: (i) real property located in the United States or the Virgin Islands, or (ii) a domestic corporation unless it is established that the corporation was not a U.S. real property holding corporation within the period described in section 897(c)(1)(A)(ii).

Treas. Reg. §1.897-1(d)(2) provides that an interest in real property other than an interest solely as a creditor includes a fee ownership, co-ownership, or leasehold interest in real property, a time sharing interest in real property, and a life estate, remainder, or reversionary interest in such property.  

The term also includes any direct or indirect right to share in the appreciation in the value, or in the gross or net proceeds or profits generated by, the real property.  A loan to an individual or entity under the terms of which a holder of the indebtedness has any direct or indirect right to share in the appreciation in value of, or the gross or net proceeds or profits generated by, an interest in real property of the debtor or of a related person is, in its entirety, an interest in real property other than solely as a creditor.

The regulations include an example of where a loan that shares in the appreciation in the value of the real property is treated as a USRPI.  The chart below demonstrates the example (click on the chart to enlarge the image):

International PLRs of the 47th Week of 2011

This week the IRS published the following Private Letter Rulings relating to international taxation:

201147002 - Late entity classification election for foreign entity

201147003 - Early Re-election of 911 exclusion

201147022 - Late IC DISC election

201147023 - Late passive foreign investment company ("PFIC") qualified electing fund ("QEF") election

International PLRs of the 46th Week of 2011

This week the IRS published the following Private Letter Ruling relating to international taxation:

201146004 - Consent was granted for an extension of time for a foreign entity to make an entity classification election under Treas. Reg. §301.7701-3(a) by filing Form 8832.

 

Subpart F Income

The earnings of foreign corporations generally are not taxed in the U.S. until the foreign corporation repatriates its earnings through the distribution of dividends.  This is known as the concept of “deferral” (i.e., U.S. taxation is deferred until repatriation).  Various exceptions to deferral exist today (often referred to as “anti-deferral” regimes).  Subpart F income is one of these exceptions to deferral. Subpart F income only applies to Controlled Foreign Corporations (CFC’s).

A CFC, very generally, is defined as a foreign corporation in which U.S. persons own more than 50 percent of the corporation’s stock (measured by vote or value).  Stock ownership includes direct ownership as well as stock owned indirectly or constructively.

When a CFC earns subpart F income, the United States generally taxes the corporation’s U.S. shareholders currently on their pro rata share thereof.  Those shareholders are effectively treated as having received current income consisting of subpart F income.

Subpart F income typically is income that is relatively movable from one taxing jurisdiction to another and that is subject to low rates of foreign tax.  Subpart F income consists of various types of income.

Earnings and profits (“E&P”) of a CFC that have been included in the income of the U.S. shareholders are not taxed again when such earnings are actually distributed to the U.S. shareholders. These earnings are known as “previously taxed income” or “PTI.”

Various special provisions apply in the application of the subpart F rules, including “de minimis” and “full inclusion” rules, and an exception for certain income subject to high foreign taxes. Furthermore, the subpart F income of a CFC is limited by its current E&P.

Foreign Personal Holding Company Income
Foreign Personal Holding Company Income (“FPHC income”) is a major type of subpart F income.  Generally, it consists of passive income such as interest, dividends, annuities, net gains from sales of property that do not generate active income, net commodities gains, net foreign currency gains, certain rents and royalties, and income from personal service contracts.

An exclusion exists for certain dividends, interest, rents, and royalties received from related corporations where the payor corporation is organized and operating in the same foreign country as the recipient.  This exclusion, often colloquially referred to as the “same country exception,” is subject to various exceptions.  Another exclusion exists for rents and royalties received from unrelated persons in the active conduct of a trade or business.

A temporary exception (known as the "CFC look-thru rule"), which has been extended several times, excludes certain dividends, interest, rents, and royalties from FPHC income, even if the paying entity is not incorporated in the same country as the recipient.

Foreign Base Company Sales Income
Foreign Base Company Sales Income is income attributable to related-party purchases and sales of personal property made through a CFC if the country of the CFC’s incorporation is neither the origin nor the destination of the goods and the CFC itself has not “manufactured” these goods.

Special branch rules can deemed certain related party transactions.

Foreign Base Company Services Income
Foreign Base Company Services Income includes income from services performed by a CFC for or on behalf of a related party where the services are performed outside the country of the CFC’s incorporation.

There are also several other types of Subpart F Income not described here.

International PLRs of the 43rd Week of 2011

The IRS published the following Private Letter Ruling relating to international taxation:

• 201143016 - Consent was granted to revoke safe harbor method elections in computing foreign tax credits with respect to a dual capacity taxpayer under Treas. Reg. §1.901-2A(c)(1).

 

International PLRs of the week

Last week the IRS published the following Private Letter Rulings relating to international taxation:

• Late passive foreign investment company ("PFIC") qualified electing fund ("QEF") elections: 
  • 201142012
  • 201142013
  • 201142014
  • 201142015

• Late PFIC mark-to-market elections:
  • 201142017
  • 201142018
  • 201142019

• Late Canadian registered retirement savings plan ("RRSP") deferral election:
  • 201142021

2012 Inflation Adjustments for Individuals in the International Tax Arena

Last week the I.R.S. published Revenue Procedure 2011-52, setting forth inflation adjusted items for 2012.  In the international arena, some of the important inflation adjustments include:

$151,000 --- Code § 877(a)(2)(A) --- The average annual net income tax that must be imposed for the five taxable years ending before the date of the loss of United States citizenship (or cessation of long-term permanent residency) for an individual to be considered a “covered expatriate” under Code § 877A(g)(1).  This amount is up from $147,000 in 2011.  See Rev. Proc. 2010-40.

$651,000 --- Code § 877(a)(1) --- The amount that can be excluded from the mark-to-market gain upon expatriation of a covered expatriate.  This amount is up from $636,000 in 2011.  See Rev. Proc. 2010-40.

$95,100 --- Code § 911(b)(2)(D)(i) --- Foreign earned income exclusion.  This amount is up from $92,900 in 2011.  See Rev. Proc. 2010-40.

$13,000 --- Code § 2503 --- The amount of the annual gift tax exclusion for gifts to any person.  This amount is the same at $13,000 as in 2011.  See Rev. Proc. 2010-40. 

$139,000 --- Code § 2523(i) --- The amount of the annual gift tax exclusion for gifts to non-citizen spouses.  This amount is up from $136,000 in 2011.  See Rev. Proc. 2010-40. 

$14,723 --- Code § 6039(F) --- Notice of large gifts received from foreign persons.  This amount is up from $14,375 in 2011.  See Rev. Proc. 2010-40.

New Brunswick Premier Caught in U.S. Tax Net

New Brunswick’s Premier (a premier is a province's head of government, much like a governor of a state in the U.S.), David Alward, recently announced that he is filing U.S. tax returns back to 2003.  Alward is a dual U.S./Canadian citizen.  He was born in Massachusetts, but has not resided in the U.S. since he was quite young.

An article by the Telegraph-Journal mistakenly attributes Alward’s current need to file U.S. tax returns with the Foreign Account Tax Compliance Act (FATCA), enacted in 2010 as part of the Hiring Incentives to Restore Employment.  The Premier, as a U.S. citizen, is obligated to file U.S. tax returns just as any other U.S. citizen. 

Sometimes taxpayers living outside the U.S. are under the impression that they only need to file U.S. tax returns if they reside in the U.S. or if they have U.S. source income.  Although this would be correct for most other countries (most other countries tax based on residency), the U.S. is an exception.  All U.S. citizens, regardless of where they live and regardless of whether they may also be citizens of other countries, are subject to U.S. tax on their worldwide income. 

Double taxation can typically be avoided through foreign tax credits and/or income tax treaties.  However, in some instances, double taxation can result.

Goosen v. Commr. - Golfer Endorsement Fees

In a recent Tax Court case, 136 T.C. No. 27 (2011), the court was asked to determine the U.S. taxation of certain endorsement fees and bonuses received by a professional golfer --- Retief Goosen (a.k.a. the “Iceman”).

Goosen received golf tournament prize winnings as well as on-course and off-course endorsement fees.  For U.K. tax purposes, Goosen’s income was paid to two corporations in which he entered into employment agreements.  A portion of this income was then paid to him as a salary.

The Tax Court had to first determine whether the endorsement fees would fall within the category of royalty income or personal services income.  After deciding the type of income, the court had to determine the source of the royalties and services income.  Next, the court had to determine whether the different streams of income were effectively connected to a U.S. trade or business.  Lastly, for the U.S. source royalties that were not effectively connected income, the court had to determine whether the U.K.-U.S. Income Tax Treaty would apply to reduce the 30% U.S. tax on the royalties.

Below is a chart which shows the types of income earned by the Iceman and how the court held each type of income should be treated.  A PDF version of the chart can be found at Goosen.

Notice 2011-64: Countries Qualifying for Reduced Dividend Tax Rates

Since 2003, dividends paid to individual shareholders from either a domestic corporation or a "qualified foreign corporation" are subject to tax at the reduced rates applicable to certain capital gains.  A qualified foreign corporation includes certain foreign corporations that are eligible for benefits of a comprehensive income tax treaty with the United States.  Notice 2011-64 provides the most recent list of the U.S. income tax treaties that meet the requirements under Code §1(h)(11). 

The previous lists of the comprehensive income tax treaties were in Notices 2003-69 and 2006-101.  The newest list in Notice 2011-64 adds Bulgaria and Malta.  

Notice 2011-64 also specifies that for purposes of determining whether the limitation on benefits clause of the treaty is met, the foreign corporation must be "treated as though it were claiming treaty benefits, even if it does not derive income from sources within the United States."

The following is a list of the treaties from Notice 2011-64:

Australia
Austria
Bangladesh
Barbados
Belgium
China
Cyprus 
Czech Republic 
Denmark 
Egypt 
Estonia 
Finland 
France
Germany 
Greece 
Hungary 
Iceland 
India 
Indonesia 
Ireland 
Israel 
Italy 
Jamaica 
Japan 
Kazakhstan 
Korea 
Latvia 
Lithuania 
Luxembourg 
Malta
Mexico 
Morocco 
Netherlands 
New Zealand 
Norway 
Pakistan 
Philippines 
Poland 
Portugal 
Romania 
Russian Federation 
Slovak Republic   
Slovenia 
South Africa 
Spain 
Sri Lanka 
Sweden 
Switzerland 
Thailand 
Trinidad and Tobago 
Tunisia 
Turkey 
Ukraine 
United Kingdom 
Venezuela

 

Q2 of 2011 Had the Second Highest Number of “Published Expatriates”

Earlier this month the Treasury Department published the names of certain individuals who renounced their U.S. citizenship or terminated their long-term U.S. residency (“expatriated”) during the second quarter of 2011.

Only expatriated individuals subject to Code §877 or Code §877A are listed in the Federal Register.  In general, this only includes expatriated individuals that have a net worth of at least $2,000,000 or that have an average annual U.S. income tax of more than $147,000.  For convenience, the expatriated individuals who have had their names published in the Federal Register are referred to as “Published Expatriates.”

The number of Published Expatriates for the second quarter of 2011 was 519.  This is the second highest number of quarterly Published Expatriates during the past seven years.  The only higher quarter during this time was the second quarter of 2010, with 560 Published Expatriates.

If current trends continue, the number of Published Expatriates for 2011 will exceed 2010 by 30% or more.  The following graph shows the quarterly average number of Published Expatriates since 2004.

The following graph shows the raw quarterly data of Published Expatriates since 2004.

The names of the Published Expatriates for the most recent quarter can be found here (see pages 312 to 319 of the PDF file).

U.K. Remittance Basis Charge (“RBC”) is a Creditable Tax

In Rev. Rul. 2011-19, the I.R.S. held that the U.K. Remittance Basis Charge (“RBC”) is an income tax for which a credit is allowable under Code §901.

The U.K. generally allows individuals who are U.K. residents but who are not domiciled in the United Kingdom (i.e., do not intend to live in the United Kingdom permanently) (non-domiciliaries) to elect each year to be taxed on an alternative basis.  The default basis of taxation for non-domiciliaries – as it is for any U.K. resident individual – is to pay U.K. income and capital gains taxes on their worldwide income and capital gains (gains), which is known as the arising basis of taxation.

The alternative method of taxation is the remittance basis, under which non-domiciliaries with non-U.K.-source income or gains can elect to be taxed on their non-U.K.-source income and gains only when they are remitted to the United Kingdom.  Remittance basis taxpayers also are subject to tax on their U.K.-source income and gains, which are taxed in the year in which they arose, under separate statutory provisions applicable to all U.K. resident individuals.

A special rule applies to U.K. residents who are non-domiciliaries age 18 years or older and who were U.K. residents in at least seven of the prior nine taxable years (long-term non-domiciliaries or “LTNDs”).  Under this rule, a LTND who elects the remittance basis of taxation is required to pay the RBC of £30,000 in addition to the remittance basis tax.

Rev. Rul. 2011-19 concludes that the RBC of £30,000 is an “income tax” for which a credit is allowable under Code §901.

Dagres - Ordinary Loss for Bad Debt of Private Equity Fund Manager

Below is a chart of a recent Tax Court case.  The Tax Court described in detail the structure of typical private equity fund, with a 2% fee and a 20% profits interest being received by the fund managers.  A PDF version of the chart can be found at Dagres.



Double Taxation on Services

Countries often impose withholding taxes on payments to nonresidents for the performance of services.  For instance, the U.S. imposes a 30% withholding tax on certain U.S. source payments, including payments for services, to nonresidents.  Code §§871(a)(1)(A) and 881(a)(1).  The U.S. withholding tax is only imposed on “U.S. source” income.  In the context of services, this generally means services performed in the U.S.  Code §861(a)(3) and Treas. Reg. §1.861-4.

A number of countries, however, impose withholding taxes on services payments to nonresidents, regardless of where the services are performed.  See, for instance, Chile and Costa Rica.  In these circumstances, double taxation can occur. 

The U.S. normally avoids double taxation by allowing a tax credit (the “foreign tax credit”) for foreign income taxes paid (foreign gross withholding taxes are generally considered “income taxes” for purposes of Code §901 --- see, for instance, Rev. Rul. 69-446 and Rev. Rul. 74-82). 

However, in general the foreign tax credit is limited to the amount of U.S. tax imposed on foreign source income.  If services are performed in the U.S., the services would be U.S. source income and the foreign tax credit allowed with respect to that income would be zero.  Thus, if another country were to tax services performed in the U.S., the income likely would be subject to both foreign and U.S. income taxes.

U.S. income tax treaties typically prevent this double taxation under “avoidance of double taxation” articles.  However, in the absence of a treaty, double taxation can occur.

The “Repatriation IRA” [To Stimulate the Economy]

Large U.S. based multinationals have been lobbying for a repatriation holiday where offshore profits are brought back to the U.S. and only taxed at a rate of 5.25%, similar to the 2004-2005 repatriation holiday.  Many argue that the repatriation of the offshore profits will stimulate the U.S. economy.

I propose a comparable benefit for individuals --- let’s call it the “Repatriation IRA.”  Under the Repatriation IRA, individuals can contribute up to 75% of their taxable income each year into an IRA so that their taxable income is reduced by 75%.  As a result, they are only subject to current income tax on 25% of their income, and the earnings in the Repatriation IRA are not taxed until distributed.

At the end of each seven year period, the individuals are given the option of withdrawing the funds from the Repatriation IRA at a tax rate of 5.25%.  Individuals who do not elect to withdraw from their Repatriation IRA can continue to defer tax.

One of the major benefits of the Repatriation IRA is the massive stimulation to the U.S. economy in year seven, when many of the individuals withdraw from their Repatriation IRAs and have lots of cash to spend.

Is the Limitation On Benefits Provision in the Proposed Hungary Treaty Too Complex?

Complexity

There is a lot a talk in the tax world about how complexity in the tax code (i) decreases levels of voluntary compliance, (ii) increases costs of compliance for taxpayers, (iii) reduces perceptions of fairness, and (iv) increases difficulties in the administration of tax laws.

U.S. income tax treaties can be complex and challenging documents to read and understand.  The reader must first get used to the terminology, such as “the Contracting States,” “the first-mentioned Contracting State,” “the other Contracting State,” etc.

The reader must also understand that U.S. income tax treaties include an overarching exception, called a “saving clause,” which provides that the treaty does not limit the U.S. taxation of U.S. citizens or U.S. residents.  See, e.g., Article 1, paragraph 4 of the U.S. Model Income Tax Treaty.  Of course, there are exceptions to this exception.

The benefits of income tax treaties are generally only available to residents of the two countries that have entered into the treaty.  Further, to prevent treaty shopping, U.S. income tax treaties include a limitation on benefits article, which further limits the benefits of the treaty.

Limitation On Benefits

Under the limitation on benefits article of U.S. income tax treaties, the benefits of the treaty are available only if the resident meets additional requirements.  Often, the treaty provides that the benefits of the treaty are available only if the resident is a “qualified person” (typically individuals, the governments of the two countries, certain publicly traded companies and their subsidiaries, pension funds, tax exempt organizations, and others meeting an ownership / base erosion test).

Further, even if the resident is not a qualified person as defined in the treaty, if the resident meets an active trade or business test, then it may qualify for benefits on certain items of income.  Lastly, if the tax authority of the country that would otherwise impose the tax determines that treaty benefits should be allowed, then the benefits of the treaty would apply.

Other Tests

The above tests are the “standard” limitation on benefits tests.  The tax laws of each country differ, and therefore some U.S. income tax treaties include additional tests. 

In a situation called a “triangular case,” a resident of a treaty country has a permanent establishment in a third country and the profits of that permanent establishment are subject to a tax rate in the third country that is substantially below the tax rate that would have applied if the profits had been taxed in the resident’s own country.  In this situation, the benefits of the treaty generally do not apply with respect to the profits earned by the permanent establishment in the third country.

Some treaties provide that the benefits of the treaty apply if a “derivative benefits” test is met.  Other treaties provide that the benefits of the treaty apply if a “headquarters company” test is met.

Hungary Treaty

The proposed income tax treaty between the United States and Hungary (the “Proposed Hungary Treaty”) was signed on February 4, 2010, and is accompanied by official understandings implemented by an exchange of diplomatic notes carried out on that same day.  The Senate Committee on Foreign Relations held a public hearing on the Proposed Hungary Treaty on June 7, 2011.

The limitation on benefits article of the Proposed Hungary Treaty includes all of the standard limitation on benefits tests, as well as the triangular cases limitation and the derivative benefits and headquarters tests.  The Joint Committee on Taxation’s written summary of this one article in the treaty spans a full 12 pages of single-spaced text.

One might wonder whether including all of these rules in the Proposed Hungary Treaty creates more costs as a result of complexity than it benefits by avoiding treaty shopping.

Free Section 736 Flowchart

Today our sister website, Tax-Charts.com, published a free flowchart that deals with payments to a retiring partner or a deceased partner’s successor in interest under Code §736.  The flowchart identifies which payments should be considered Code §736(a) payments (distributive share or guaranteed payment) and which payments should be considered Code §736(b) payments (in exchange for the withdrawing partner’s interest in partnership property).

The flowchart is available for free here and a printable version of the flowchart can be found here.

YouTube Video on Busted Section 351 Exchanges

Today we uploaded our first YouTube video.  The video reviews Rev. Rul. 70-522 and its busted section 351 exchanges.  Please forgive the audio quality --- this is our first video.

   

Flowchart of LOB Article of Chile-U.S. Income Tax Treaty

Today our sister website, Tax-Charts.com, published a flowchart that deals with the limitation on benefits ("LOB") provisions included in Article 24 of the Chile-U.S. Income Tax Treaty.  Although the treaty has been signed, it has not yet been ratified and is not yet in force.

The limitation on benefits provisions are intended to prevent treaty shopping. The flowchart includes the various types of qualified persons and includes the Publicly Traded Test, the Ownership / Base Erosion Test, the HQ company test, the Active Business Test, Triangular Cases, etc.

The flowchart can be purchased on Tax-Charts.com for US$69.

 

 

U.S. Government Continues to Pursue Taxpayers Committing Tax Fraud

As we reported last year (Tax Crimes, Tax Fraud, Tax Schemes), the U.S. government actively pursues taxpayers that are committing tax fraud.  The Justice Department publicizes is successes in its press releases.  The press releases demonstrate an impressive list of tax-related convictions, guilty pleas, injunctions, summonses, and other actions against taxpayers (and tax preparers).  Many of the tax fraud schemes include offshore activities.  See, for instance:

1. New Jersey UBS client sentenced for failing to report more than $750,000 in Swiss bank account
   
2. Bank director charged with hiding foreign assets
   
3. New York woman pleads guilty to filing a false tax return; did not report her HSBC India bank account held $8.3 million
   
4. Justice Department asks court to allow IRS to seek HSBC India bank account records
   
5. UBS client sentenced in San Diego for hiding assets in secret Bahamian and Swiss bank accounts
   
6. Former UBS client sentenced for hiding millions in offshore bank accounts
   
7. Four Swiss bankers charged with helping U.S. taxpayers use secret accounts at Swiss banks to evade U.S. taxes
   
8. New Jersey UBS client sentenced for failing to report more than $1 million in Swiss bank account

 

Transactions Between Related Parties Merit Extra Scrutiny

Continuing our series on Famous Tax Quotes (quotes from court opinions and rulings with language that is colorful or that concisely states an important tax principle) today's tax quote is:

[T]ransactions between related parties merit extra scrutiny.

Merck & Co. v. U.S., ___ F.3d ___ (3d Cir. 2011)

I.R.S. Delays Annual Reporting for Foreign Financial Assets and P.F.I.C.s

Foreign Financial Assets

Under recently enacted Code §6038D(a), any individual who during the taxable year holds an interest in any specified foreign financial asset is required to attach to his or her income tax return for the taxable year certain required information with respect to each specified foreign financial asset if the aggregate value of all of the individual’s specified foreign financial assets exceeds $50,000.  Code §6038D applies to taxable years beginning after March 18, 2010.  The I.R.S. intends to, but has not yet, released Form 8938, Statement of Specified Foreign Financial Assets.  Notice 2011-55 suspends the requirement to attach Form 8938 to income tax returns that are filed before the release of Form 8938.

P.F.I.C.s

Under recently enacted Code §1298(f), U.S. persons who are shareholders of a passive foreign investment company (P.F.I.C.) are required to file an annual report with the I.R.S.  Prior to the enactment of Code §1298(f), P.F.I.C. shareholders were required to file Form 8621 in certain circumstances (but not annually).  Code §1298(f) was effective on March 18, 2010.  However, Notice 2010-34 provided that shareholders of a P.F.I.C. that were not otherwise required to file Form 8621 annually prior to the enactment of Code §1298(f) would not be required to file an annual report as a result of the addition of Code §1298(f) for taxable years beginning before March 18, 2010.  Pending the release of a revised Form 8621, Notice 2011-55 further suspends the Code §1298(f) reporting requirement for taxable years beginning on or after March 18, 2010, for P.F.I.C. shareholders that are not otherwise required to file Form 8621 as provided in the current instructions to Form 8621.  P.F.I.C. shareholders with Form 8621 reporting obligations as provided in the current instructions to Form 8621 must continue to file the current Form 8621 with an income tax or information return filed prior to the release of a revised Form 8621.

This notice does not relieve a person of the responsibility to file Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts, (“FBAR”) if the FBAR is otherwise required to be filed.

Clarification of Expatriate Graph

See Expatriate Graph "Re-Clarified" for a correction to this post.

It has been brought to my attention that my graph of expatriate individuals is misleading.

My graph only includes the number of expatriates that have been listed in the Federal Register.  Only certain expatiates are listed in the Federal Register. 

Only individuals to whom Code §877 (pre-June 17, 2008) or 877A (post-June 16, 2008) applies are listed in the Federal Register.  Therefore, the graph does not include ALL individuals that have renounced their U.S. citizenship or long term permanent residency.  This fact should have been explicitly indicated.

Code §877 or 877A applies to individuals that:.

1. have a net worth of $2,000,000 on the date of expatriation, 
2. have an average annual net income tax for the period of 5 years ending before the date of the loss of citizenship/permanent residency of more than $124,000 (the amount is annually adjusted for inflation and the amount for 2011 is $147,000), or 
3. do not certify to the I.R.S. that they have met their U.S. tax obligations for the 5 preceding taxable years.

Therefore, in general, only individuals that meet certain asset or income thresholds are included in the graph.  Some might say that only “wealthy” individuals who have expatriated are included. 

I apologize if any readers have been mislead.  For future graphs of expatriates, I will make sure that this distinction is clear.

Additional Extension for Pre-2010 Signature Authority Only FBARs

In Notice 2011-54, the I.R.S. has provided an additional extension for persons having signature authority over, but no financial interest in, a foreign financial account in 2009 or earlier calendar years for which the reporting deadline was extended by Notice 2009-62 or Notice 2010-23.  These persons now have until November 1, 2011, to file FBARs with respect to those accounts. The deadline for reporting signature authority over, or a financial interest in, foreign financial accounts for the 2010 calendar year remains June 30, 2011.

Two New Flowcharts on Tax-Charts.com

Today our sister website, Tax-Charts.com, uploaded two new flowcharts.  One flowchart deals with the limitation of benefits clause of the Ireland-U.S. Income Tax Treaty and the other flowchart deals with the limitation of benefits clause of the Mexico-U.S. Income Tax Treaty.

The flowchart regarding the Mexico-U.S. Income Tax Treaty is available for free (here and a printable version of the flowchart can be found here) and the flowchart regarding the Ireland-U.S. Income Tax Treaty is available for purchase for $69 on Tax-Charts.com.

U.S. Citizens Continue to Renounce

Last month the Treasury Department published the names of individuals who renounced their United States citizenship or terminated their long-term U.S. residency (“expatriated”) during the quarter ending March 31, 2011.  A total of 499 individuals expatriated during this quarter.  While 499 is not the highest number of quarterly expatriates in recent history, the quarterly average number of expatriates continues to increase.  The following graph shows the quarterly average number of expatriates for the past 4 years.

 

The following is a graph of the raw quarterly data since 2004.

 
 
 

For earlier coverage of expatriates see here.

 

10 Free New Tax Charts (June 2011)

Today we added 10 free charts to www.andrewmitchel.com.  The recently added charts can be found here.  The charts include the following:

1. Soreng (Disproportionate Circular Flow of Cash Not Disregarded)
2. Rev. Rul. 68-183 (Sale to Trust Treated as Contribution to Trust)
3. Rev. Rul. 69-142 (B Reorganization Treated As Separate From Exchange of Debentures)
4. Rev. Rul. 69-608, Situation 1 (Constructive Dividend for Corporate Assumption of Shareholder Liability)
5. Rev. Rul. 76-454 (Constructive Dividend as Part of 351 Exchange)
6. Rev. Rul. 2007-42 Situation 2 (Failed Spin-Off - 20% Interest in Partnership)
7. Notice 2007-57 (Loss Importation Listed Transaction)
8. Rev. Rul. 2008-31 (Notional Principal Contract Was Not a USRPI)
9. PLR 201106003 (CFC/PFIC Overlap Rule For a U.S. Partnership)
10. Section 304(b)(5)(B) (Anti-abuse Rule for Redemptions of U.S. Corporations in Foreign Sandwich Structures)

Offshore Structure to Hold Iraqi Dinars?

I have received a number of inquiries recently regarding the taxation of gains associated with the disposition of Iraqi dinars.  Some of the inquiries have related to the formation of an offshore structure (such as an offshore trust, foundation, corporation, etc.) to hold the Iraqi dinars.

If you are a U.S. citizen or a U.S. resident, the short answer to the question of whether you should set up such a structure is “no.”  The long answer is the same - “No, you should not set up an offshore structure to hold your Iraqi dinars.”

Make sure that you speak with a qualified U.S. tax advisor before setting up or being associated with any non-U.S. entity, corporation, partnership, structure, trust, foundation, etc.  The penalties for simply failing to disclose to the I.R.S. various offshore transactions can be huge.

The amount of U.S. tax imposed on the sale of an asset can increase when held through an offshore structure.  A qualified U.S. tax advisor can help you understand what disclosure rules and potential penalties may apply, as well as the risks, costs, and benefits of setting up an offshore structure.

Flowchart of Rev. Proc. 93-27

Today our sister website, Tax-Charts.com, uploaded a free flowchart that deals with the taxation of profits interests under Rev. Proc. 93-27.  The flowchart includes the clarifications of Rev. Proc. 93-27 made in Rev. Proc. 2001-43, regarding the receipt of partnership interests that are not yet vested (as defined in Treas. Reg. §1.83-3(b)).

The flowchart can be found here and a printable version of the flowchart can be found here.

Doctrine of Cloth[e]ing

The follow are excerpts from various tax cases discussing a taxpayer’s attempts to “clothe” a transaction to disguise its true form.

Lynch v. Commr, 31 T.C. 990 (1959):

A commonly encountered problem, however, is that a taxpayer, seeking to avoid taxation, will clothe a transaction and make it appear to be something which in reality it is not.

Federal Oil Company v. Commr, 25 TCM 996 (1966):

It is true that the Court is not bound by the form in which parties to an agreement clothe their transaction but is charged with the duty of determining the realities of the transaction after having considered all the pertinent facts.

Copperhead Coal Company, Inc. v. Commr, 17 TCM 30 (1958):

It is well established that the form in which a taxpayer chooses to clothe its transactions does not bind the Government for tax purposes.

Skinner v. Commr, 27 TCM 680 (1968):

 [T]he form chosen by the parties to clothe that slice of reality cannot dictate the application of the statute.

Commr v. Kohn, 158 F.2d 32 (4th Cir. 1946):

The circumstances are merely external garments that clothe the transactions, outward trappings at best.  In no way do they condition the essential verities.

Cairo Developers, Inc. v. U.S., 381 F.Supp. 431 (1974):

[T]he taxpayers attached the “sale” label to the transfers of land and tried to clothe the transactions with appropriate documents and other indicia of a bona fide sale and debtor-creditor relationship.

Glazer v. Commr, 44 T.C. 541 (1965):

We think that on the facts before us there was in substance no real sale of partnership interests in this case, notwithstanding the efforts of petitioners and their attorney to clothe the transaction in that form.

Anagnoston v. Commr, 68 TCM 146 (1994):

[P]etitioners have gone to great lengths to clothe in “sales” garb transactions that are not sales . . . .

Earp v. Commr, 131 F.2d 292 (10th Cir. 1942):

All he did was to clothe himself in the cloak of a partnership, but when the cloak was removed, there stood the same individual, doing business in substantially the same way . . . .

Blair v. Commr, 300 U. S. 5 (1937):

 . . . attempting to clothe the transaction in the guise of a transfer of trust property rather than the transfer of income where that is its obvious purpose and effect.

Collins v. Commr, 54 T.C. 1656 (1970):

[S]uch reporting . . . was to be part of the transparent pretension that was designed to clothe the payment with the garb of interest.

American Realty Trust v. U.S., 498 F.2d 1194 (1974):

[C]lothe a loan in the superficial garb of a sale-and-lease-back.

Culligan Water Conditioning v. U.S., 567 F.2d 867 (9th Cir. 1975):

[W]e should remain free to examine all the facts in order to determine whether there exists a plan or agreement to dispose of control regardless of the formalities with which the parties may choose to clothe their intentions.

First National Corporation of Portland v. Commr, 2 T.C. 549 (1943):

The form in which [the parties] chose to clothe the transaction invites this argument. Nevertheless we think the contention is unsound.

Should “goodwill” be one word or two words?

I have recently been typing the word “goodwill,” and I wondered whether it was grammatically preferable for the word to be one or two words.  My dictionary says it can be either one.  I decided I wanted to use the same convention as used in the U.S. tax arena.  Therefore, I looked in the statute of the section in which I was dealing (section 882) and saw that it was listed as two words.  I thought this settled the matter.

However, today I was looking in another Code section (section 865) and I saw that goodwill was listed as one word.  Intrigued, I thought that perhaps one of the sections was an outlier and that most Code sections would be consistent, one way or the other.

To my surprise, after searching the Code (in CCH, at least), I realized that there was no consistency.  Seven Code sections used goodwill as one word (Code sections 167, 197, 338, 865, 901, 1060, and 2036) and nine Code sections used good will as two words (Code sections 401, 736, 871, 861, 862, 881, 882, 927, 993).

Hmmm.  What to do?

I.R.S. Reporting of Bank Interest Paid to NRAs

In 2001, the I.R.S. and Treasury Department published proposed regulations which would have provided that U.S. bank deposit interest paid to nonresident alien individuals ("NRAs") would be reported annually to the I.R.S.  In 2002, the proposed regulations were withdrawn and narrower proposed regulations were published that would require reporting only interest payments to NRAs of certain designated countries.  The 2002 proposed regulations were never finalized.

In January 2011, the I.R.S. and Treasury Department withdrew the 2002 proposed regulations and published new proposed regulations which would again require the information reporting of interest paid to NRAs of any foreign country.

The rationale for the rule appears to be that the I.R.S. would like to receive information with respect to interest paid by foreign banks to U.S. citizens and U.S. residents from other countries.  As a quid pro quo, the tax authorities of other countries would like to receive similar information from the U.S.  However, the I.R.S. cannot provide this information to other countries if it doesn’t even collect the information.  Thus, the new proposed regulations would require the collection of this information.

Valuation Is Not an Exact Science

Continuing our series on Famous Tax Quotes (quotes from court opinions and rulings with language that is colorful or that concisely states an important tax principle) today's tax quote is:

The determination of the fair market value of stock depends upon the circumstances in the particular case.  However, since valuation is not an exact science, reasonableness must be exercised in making determinations of value.

Rev. Rul. 77-245

NPR Podcast on Double Irish Structure

NPR’s Fresh Air program yesterday (March 17, 2011) interviewed Jesse Drucker, a Bloomberg News reporter, about the Google "Double Irish" structure.  The interview was titled “How Offshore Tax Havens Save Companies Billions.”

The interview is about 20 minutes long and is quite good.

Very definitely . . . probably

Continuing our series on Famous Tax Quotes (quotes from court opinions and rulings with language that is colorful or that concisely states an important tax principle) today's tax quote is:

"The court very definitely indicated that a different conclusion would probably have been reached if the amount retained was clearly in excess of a reasonable amount necessary to liquidate liabilities."

Rev. Rul. 57-518

Congress Can "label a thing income and tax it"

Continuing our series on Famous Tax Quotes (quotes from court opinions with language that is colorful or that concisely states an important tax principle) today's tax quote is:

". . . [A]lthough the "Congress cannot make a thing income which is not so in fact," it can label a thing income and tax it, so long as it acts within its constitutional authority, which includes not only the Sixteenth Amendment but also Articl 1, Sections 8 and 9."

Murphy v. IRS, D. C. Circuit 493 F3d 170 (2007)

Number of Expatriates More Than Doubles

The number of individuals expatriating from the U.S. more than doubled in 2010.  Expatriating individuals include people that either renounce their U.S. citizenship or terminate their long-term U.S. permanent residency.

In 2009, the total number of expatriates was 742.  In 2010, the number increased to 1,534 --- a 207% increase.  Last year had perhaps the highest number of expatriates in any year in U.S. history.  I anticipate that this trend will continue.

Shown below is a chart of the number of annual expatriations for the past 7 years.

  

Andrew Mitchel is an international tax attorney who advises businesses and individuals with cross-border activities.