The Tax Court in Inverworld v. Commr., 71 TCM 3231 (1996), concisely stated the U.S. tax rules for foreign corporations that have activities in the U.S.:
Foreign corporations operating in the United States are subject to two U.S. taxation regimes. Under the first regime, a foreign corporation engaged in trade or business within the United States during the taxable year is taxable on its income which is effectively connected with the conduct of such trade or business within the United States (effectively connected income). Effectively connected income can originate from sources within the United States * * * or from sources without the United States, * * * and is taxed at the same [graduated] rates that apply to a U.S. corporation under section 11.
Under the second regime, a flat tax of 30 percent is imposed on a foreign corporation's gross income from “interest * * *, dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, and other fixed or determinable annual or periodical gains, profits, and income”, but only to the extent the amount is received from sources within the United States and is not effectively connected with the conduct of trade or business by such corporation within the United States. A foreign corporation is not subject to tax on its income which is not effectively connected with its conduct of trade or business within the United States and which is received from sources without the United States.
In sum, if [the foreign corporation] is engaged in trade or business within the United States, income items effectively connected with [the foreign corporation’s] trade or business * * * are taxed * * * at regular corporate rates; income items not effectively connected with any trade or business conducted by [the foreign corporation] within the United States, if sourced from within the United States, are taxed at 30 percent * * *, but if sourced from without the United States, are not subject to U.S. taxation. [Citations omitted.]
Similar rules apply to foreign individuals.
The Inverworld case dealt with an entity that was engaging in the banking, financing, or similar business. As a result, the Tax Court found that a regulation dealing with banking, financing, or similar businesses (Treas. Reg. §1.864-4(c)(5)(i)) provided a “useful framework” for analyzing whether the foreign corporation was engaged in the conduct of a trade or business in the U.S. (“ETOB”). For foreign taxpayers not engaging in the banking, financing, or similar business, different rules would be used to determine whether the foreign person is ETOB. Generally, foreign persons are ETOB if they have “considerable, continuous, and regular” business activities in the U.S. Pinchot v. Commr., 113 F.2d 718 (2d Cir. 1940), Lewenhaupt v. Commr., 20 T.C. 151 (1953), and De Amodio v. Commr., 34 T.C. 894 (1960).
Some people believe that there is a bright line test that allows them to avoid being ETOB by only acting through independent agents in the U.S. There is no such bright line test. In fact, foreign persons can be ETOB even though they are utilizing only independent agents in the U.S.
In De Amodio v. Commr., 34 T.C. 894 (1960), the Tax Court held that a nonresident alien was engaged in a trade or business in the United States when the nonresident alien acquired real property through a real estate agent and managed the properties through other local real estate agents. The Tax Court concluded that the nonresident alien’s conduct of considerable, continuous, and regular activities “through his agents in the United States” caused the nonresident alien to be ETOB. The Tax Court held that the nonresident alien’s agents were independent agents for purposes of the Switzerland-U.S. Income Tax Treaty, such that the nonresident alien was not treated as having a permanent establishment in the U.S.
In addition, Rev. Rul. 55-617 held that a foreign corporation was engaged in trade or business within the U.S. when it marketed goods in the U.S. through what was apparently an independent commission agent.
Therefore, it is possible for U.S. activities of independent agents to cause a foreign person to be ETOB. Having said that, there is some force to the argument that the use of independent agents in the U.S. should be less likely to cause a foreign person to be ETOB, as compared to the foreign person’s use of dependent agents in the U.S. The determination whether a foreign person is ETOB is highly factual. Such determination must be made by analyzing the facts and circumstances of each case. Rev. Rul. 88-3.
UPDATE 12/26/20: See also PMTA 93-6930 (1996) (“section 865(b) could apply, for example, where the nonresident is engaged in a U.S. trade or business through an independent agent”).