Today we added some new quizzes to our sister website, Tax-Charts.com. The quizzes are still a bit of a work-in-process, but if you want to test your tax knowledge, check them out at Quizzes. The quizzes added today are all tax cases dealing with the following topics:
We had previously created quizzes for tax cases dealing with:
Today our sister website, Tax-Charts.com, published a free flowchart regarding the requirements for a “tax-free” exchange under Code §351. The flowchart is a simplified version of the previously published (and also free) Code §351 flowchart. The simplified version addresses the three primary requirements under Code §351 (transfer of property, in exchange for stock, and control) in an abbreviated manner.
Visit Tax-Charts.com to access the Code §351 exchange flowchart, to view other free tax flowcharts, or to purchase flowcharts.
We also added three new flowcharts (available for purchase) to Tax-Charts.com dealing with the sourcing of income. The three flowcharts include:
The inventory sourcing flowchart deals with both manufactured inventory (including the 50/50 method and the independent factory price ["IFP"] method) as well as non-manufactured inventory (including the special rules for inventory sales by foreign persons thru U.S. offices or fixed places of business).
The non-inventory sourcing flowchart includes sourcing of depreciation recapture, the special rules dealing with intangible property sold for contingent consideration, the special sourcing residency rules under Code §865(g), and the special office or fixed place of business rules for residents and nonresidents.
The “other” sourcing flowchart deals with the other categories of income, such as interest income, dividend income, personal services, rentals and royalties, disposition of real property, insurance underwriting, social security benefits, guarantee fees, scholarships, prizes and awards, transportation income, international communications income, space and ocean income, notional principal contracts, and analogy.
Because the sourcing rules can be quite detailed, a “simplified” version of each flowchart is included. These sourcing flowcharts are available for purchase at Tax-Charts.com.
This week the IRS published the following Private Letter Rulings and Chief Counsel Advice relating to international taxation.
PLR 201343011 - Late IC DISC election. Form 4876-A, Code §992(b)(1)(A).
PLR 201343014 - Late Canadian registered retirement savings plan ("RRSP") deferral elections. Form 8891. Rev. Proc. 2002-23.
PLR 201343017 - Late Canadian registered retirement savings plan ("RRSP") deferral elections. Form 8891. Rev. Proc. 2002-23.
CCA 201343019 - A Cypriot holding corporation qualifies for benefits under the U.S-Cyprus Income Tax Treaty and therefore its U.S. shareholders receive a reduced rate of tax on dividends.
CCA 201343020 - Earnings of a foreign distributor based on purchases of a U.S. corporation's products by lower-tier distributors in the foreign distributor’s sponsorship chain constitute income from performance of personal services by the foreign distributor.
CCA 201343023 - Where a partnership has no domestic partners eligible to be the tax matters partner ("TMP"), a foreign partner may be selected. Treas. Reg.301.6231(a)(7)-1(b)(2).
Last week the IRS published the following Private Letter Rulings and Chief Counsel Advice relating to international taxation.
PLR 201311001 - Consent was granted to change methods for measuring and timing and identifying employee stock options, restricted stock units, and performance-based restricted stock units pursuant to Treas. Reg. §1.482-7(d)(3)(iii)(C) for purposes of determining the amount the taxpayer must include in its cost sharing arrangement as intangible development costs.
PLR 201311004 - The generation-skipping transfer tax does not apply to taxable distributions or taxable terminations to the extent the initial transfer of property to the trust by a nonresident alien transferor was not subject to the federal estate or gift tax. Distributions from a foreign estate and terminating distributions from a foreign trust were not subject to generation-skipping transfer tax.
PLR 201311006 - Lawsuit damages payments were excluded from the gross income of nonresident aliens under Code §104(a)(2). Consequently, the payments were not subject to withholding under Code §1441.
PLR 201311008 - Late entity classification election for a foreign entity to be treated as an association. Form 8832. Treas. Reg. §301.7701-3(c).
PLR 201311013 - Late entity classification election for a foreign entity to be treated as a disregarded entity. Form 8832. Treas. Reg. §301.7701-3(c).
PLR 201311014 - Late passive foreign investment company ("PFIC") mark-to-market election. Form 8621. Treas. Reg. §1.1296-1(h).
PLR 201311018 - Consent granted to prospectively change method for measuring employee stock options and restricted shares as well as the method for identification pursuant to Treas. Reg. §1.482-7(d)(3)(iii)(C) and Notice 2005-99.
CCA 201311024 - 863(c), ocean activity income vs. transportation income from leasing a vessel.
Today the IRS published the following Chief Counsel Advice relating to international taxation:
CCA 201205007: Credit card interest income earned by U.S. citizens and resident alien customers living outside the U.S. was foreign source income. The CCA relied upon the substantial presence test to determine U.S. or foreign residency. In addition, ATM fees earned related to ATM transactions located outside the U.S. were considered income from services that were performed in the U.S. and were therefore U.S. source income.
[I am not sure that I agree with the conclusion related to the ATM 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.
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.
Code §§ 861, 862, and 863 provide rules for determining whether a particular class of income is considered U.S. source income or foreign source income. Code §§ 861(a)(1) through (a)(7) provide rules as to when specific classes of income are sourced within the U.S. Code § 862(a) is a parallel section providing when those same classes of income are sourced outside the U.S.
The classes of income specified in Code §§ 861 and 862 include the following:
Code § 863 grants the Secretary of the Treasury authority to promulgate regulations allocating income not specified within Code §§ 861(a) and 862(a) to U.S. and foreign sources. Other sourcing rules also exist in other code sections (e.g., Code §§ 865, 988(a)(3), etc.).
When an item of income does not fall within one of the classes of income listed above, courts have sourced the item by comparison and analogy with classes of income specified with the statutes. Container Corp. v. Commissioner, 134 T.C. No. 5 (2010), Bank of America v. U.S., 680 F.2d 142 (Ct.Cl. 1982), Howkins v. Commissioner, 49 T. C. 689 (1968).
Last year the I.R.S. published Rev. Rul. 2009-14 which deals in part with the payment of death benefits under a life insurance contract to a foreign corporation not engaged in the conduct of a trade or business in the United States. In the ruling, the insured individual was a U.S. citizen residing in the U.S. and the insurance company that issued the policy was a domestic corporation.
Rev. Rul. 2009-14 properly identifies that the payment of death benefits under an insurance policy is not one of the types of income listed in Code §§ 861 and 862. The ruling then correctly identifies that “the source of such income is determined by comparison and analogy to classes of income that are specified within the statute.”
Unfortunately, the ruling does not in any way compare or analogize the payment of death benefits with the classes of income that are specified within the statute. Instead, it simply concludes that the death benefit income is U.S. source income. The conclusion seems to be based on the fact that the insured individual was a U.S. citizen residing in the U.S. and that the insurance company that issued the policy was a domestic corporation. However, it is not clear which, if any, of these factors controls.
This criticism is not to suggest that the conclusion of the ruling is inaccurate. The conclusion may very well be correct. This criticism is to simply say that there was no analysis included in the ruling to support the conclusion given.
Yesterday the Tax Court published Container Corp. v. Commissioner, 134 T.C. No. 5 (2010). This decision held that guarantee fees paid by a U.S. subsidiary of a Mexican parent were not U.S. source income, and therefore were not subject to U.S. withholding taxes of 30%.
Code § 881 imposes a 30% tax on “fixed or determinable annual or periodical” (“FDAP”) income received by foreign corporations from sources within the United States. The question presented was whether the guarantee fee paid by the U.S. subsidiary to the Mexican parent was from a source within the United States. Taxes owed under Code § 881(a) are generally withheld at the source. Code § 1442(a).
The parties agreed that the guaranty fees were FDAP income. Thus, the question was whether the source of the guaranty fees was in the United States or in Mexico.
The source of FDAP is determined by using the rules in Code §§ 861 to 863. These sections identify certain types of categories of income as being either U.S. source income or foreign source income. Before the source of the income can be determined, it is necessary to determine which category the income fits within.
The I.R.S. argued that the guarantee fees were closest to the interest category. Interest is sourced based on the residence of the obligor. Code §§ 861(a)(1), 862(a)(1); Treas. Reg. § 1.861-2. Thus, under the I.R.S.’s assertion, the guarantee fees would have been U.S. source income and subject to the 30% tax.
The taxpayer, on the other hand, argued that the guarantee fees were closest to the services category. Services are sourced to where the services are performed. Code §§ 861(a)(3), 862(a)(3); Treas. Reg. § 1.861-4. Consequently, under the taxpayer’s position, the guarantee fees would have been foreign source income and not subject to the 30% tax.
This case reminds me of Procrustes in Greek mythology. Procrustes was an inn-keeper that had a single size bed. He would force all of his patrons to fit in the bed. If they were too tall, he would cut off their legs. If they were too short, he would stretch them out.
Here, the guarantee fee doesn’t fit squarely within the category of interest or within the category of services. Consequently, the Tax Court must do some cutting and/or stretching of the guarantee fees to cause them to fit within one of the categories.
Relying on prior case law, the court proceeded to use analogy to determine whether the guaranty fees were more like interest or more like services (or, possibly, some other category of FDAP that has a specific sourcing rule).
Noting that it was deciding a close question, the Tax Court concluded that guaranties are more analogous to services than to interest. Consequently, the guarantee fees were foreign source income and the U.S. subsidiary was not required to withhold the 30% tax.
Andrew Mitchel is an international tax attorney who advises businesses and individuals with cross-border activities.
Telecommunication companies often earn several different types of income. The Internal Revenue Code and the regulations provide special sourcing rules for “international communications income.” Code § 863(e)(2) defines international communications income as income derived from the transmission of communications or data between the United States and a foreign country (or possession of the United States).
General Source Rules
Code § 863(e)(1)(A) provides that any international communications income of a United States person is sourced 50 percent in the United States and 50 percent outside the United States (50/50 source rule). Code § 863(e)(1)(B)(i) provides that any international communications income of a foreign person is sourced outside the United States, except as provided in regulations or in Code § 863(e)(1)(B)(ii).
When a taxpayer cannot establish the two points between which the taxpayer is paid to transmit the communication, Treas. Reg. § 1.863-9(f) provides a default source rule under which all the income derived by the taxpayer from such communications activity is U.S. source income.
Exception for U.S. Fixed Place of Business
The exception under Code § 863(e)(1)(B)(ii) provides that if a foreign person maintains an office or other fixed place of business in the United States, any international communications income attributable to such office or other fixed place of business is U.S. source income. Treas. Reg. §. 1.863-9(b)(2)(iii) provides that international communications income is attributable to an office or other fixed place of business to the extent of:
the U.S. office or other fixed place of business.
Exception for Controlled Foreign Corporations
The regulations provide that international communications income derived by a controlled foreign corporation, within the meaning of Code § 957, is 50 percent U.S. source income and 50 percent foreign source income (the same as for United States persons). Treas. Reg. § 1.863-9(b)(2)(ii).
Exception if Engaged in U.S. Trade or Business
Tthe regulations also provide that international communications income derived by a foreign person, other than a controlled foreign corporation, engaged in a trade or business within the United States is income from sources within the United States to the extent the income, based on all the facts and circumstances, is attributable to:
within the United States. Treas. Reg. § 1.863-9(b)(2)(iv)
The three criteria for determining the amount of U.S. source income for foreign persons with fixed places of business in the U.S. and for foreign persons engaged in the conduct of a U.S. trade or business in are the same --- the functions performed, the resources employed, and the risks assumed.
Most sourcing rules are bright-line, objective tests. The sourcing rules for foreign persons with international communications income are much more subjective. In fact, such foreign persons may require an analysis similar to a transfer pricing study under Code § 482 merely to determine the source of their international communications income.
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