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International Tax Planning Priorities for US Corporations

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Sometimes, I encounter in my practice one particularly damaging belief concerning international tax planning for US corporations that engage in cross-border transactions and maintain a foreign subsidiary or a network of foreign subsidiaries. This is a belief that international tax planning for such corporations should only focus on the reduction of its US taxes above all other considerations. I reject this one-sided view and argue for balancing of international tax planning priorities for such US corporations. In this article, I will discuss the top priorities that are subject to balancing during proper international tax planning for US corporations who operate overseas.

International Tax Planning Priorities: Tax Planning Should Correspond to Dynamic Facts

Before we outline international tax planning priorities, we need to state a rule that seems very obvious but, unfortunately, is often overlooked – tax planning must correspond to the factual situation around which the planning is done. Since a factual situation of a business is prone to rapid changes, tax planning either needs to pro-actively respond to these dynamic facts or, in cases where it is not possible, adjust to these facts as soon as possible in order to avoid a negative tax impact in the future.

This means that engaging in business transactions that spread over multiple taxing jurisdictions requires continuous tax planning, continuous monitoring of the factual background in which these transactions take place and continuous assessment of tax consequences of these activities.

This rule also means that tax planning must respond to the facts generated by the required business transaction rather than create business transactions purely to save taxes. I should point out that such purely tax-motivated schemes are also unlikely to pass judicial review.

International Tax Planning Priorities: Lower US Tax Liability

There is no question that ethically lowering US tax liability based on the opportunities and incentives present in the Internal Revenue Code is one of the most important priorities of international tax planning. As I stated above, however, this is not the only priority.

International Tax Planning Priorities: Lower Foreign Tax Liability

It is not just the US tax liability of the head office that we should be concerned about. International tax planning should also seek to lower foreign tax liability of its subsidiaries. Moreover, if lowering US tax liability comes at the cost of increasing foreign tax liability or missing an opportunity to minimize it, this outcome may not be optimal for the overall corporate structure.

International Tax Planning Priorities: Maximizing Corporate Earnings

This is a key issue that many practitioners and business owners often miss in US international tax planning. Tax planning is not only about lowering taxes at any cost. If a business is continuously losing a significant amount of money (not strategically recognizing losses, but its profits are actually reduced) because of tax planning, then such tax planning may not be worth the effort.

Effective tax planning means that a tax practitioner should coordinate tax saving efforts with business priorities. Business planning will always see to utilize corporate cash and personnel in a way that maximizes profits. Moreover, business planning will also seek to creatively allocate and move excess cash flow between corporate subsidiaries (and the head office) for the same purpose.

It is precisely the latter function of business planning that requires the most attention of international tax attorneys, because it may result in significant tax costs (which may more than offset the benefit of business planning). At the same time, tax planning must be done in such a way as to minimize the damage it can do to the business’ ability to move cash across the entire corporate structure.

Contact Sherayzen Law Office for International Tax Planning Help

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Foreign Partnership Definition | International Business Tax Lawyers

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Defining a partnership as “foreign” or “domestic” can be highly important for US tax purposes. In this article, I will explain the foreign partnership definition and explain its significance.

Foreign Partnership Definition: Importance

There may be important US international tax law consequences that stem from whether a partnership is classified as “foreign” or “domestic”. These consequences may encompass not only income tax compliance, but also the type of information returns that may have to be filed. Even tax withholding requirements may be affected by this classification.

Let me give you a few examples of where foreign partnership directly appears in the IRC (Internal Revenue Code) in order for you to appreciate the significance of the foreign partnership definition. The term foreign partnership appears in such diverse provisions as IRC §6046A (filing of information returns by U.S. persons with regard to acquisition, disposition, or substantial change of interest in foreign partnership – this is the famous IRS Form 8865), §3401(d)(2) (wage withholding), §168(h)(5) (tax-exempt entity leasing rules) and even tax withholding rules for disposition of US real property under §1445.

The main reason for this significance of the foreign partnership definition lies in §7701(a)(30), which states that a foreign partnership is not a “US Person”, a highly important term of art in US international tax law. The implications of being a “foreign person” rather than a “US person” can be huge, extending as far as affecting anti-deferral tax regimes.

Foreign Partnership Definition: Formal Partnership

Let’s delve now into the foreign partnership definition. Our starting point is §7701(a)(5); it states that a partnership is considered to be foreign as long as it is “not domestic”. §7701(a)(4) defines domestic partnership as those which were “created or organized in the United States, or under the law of the United States or of any State.”

Under §7701(a)(9), the term “United States” includes only the states and the District of Columbia. In other words, if a partnership is formally organized in any place other than the fifty states of the United States and the District of Columbia, it is a foreign partnership.

What about partnerships created or organized in US possessions? The IRS and the courts have consistently stated that they are foreign (though there are more examples of these rulings with respect to corporations rather than partnerships).

What if a partnership is chartered both in the United States and another country? Without delving too deeply into legal analysis, pursuant to Treas. Reg. §301.7701-5(a), such a partnership would be classified as a domestic entity

Foreign Partnership Definition: Common Law/Private Agreement Partnerships

The above definition only works well in cases where a partnership is formally created or organized under the laws of a country. However, it is also possible for the IRS to classify a contractual relationship as a partnership for tax purposes. In these cases, the determination of whether a partnership is a foreign or domestic for US international tax purposes is a lot more difficult.

At this point, there is no absolute clarity provided by the IRS on this issue. However, there are two main approaches for determining whether a deemed partnership is domestic or foreign that may be acceptable to the IRS: (1) the contract’s governing law; and (2) primary location of the business of the deemed partnership. Let’s review these approaches.

Foreign Partnership Definition for Deemed Partnerships: Governing Law Approach

The governing law approach to classification of partnerships as foreign or domestic states that a partnership should be classified as foreign or domestic depending on the governing law which controls the agreement that gave rise to the deemed partnership.

The IRS often likes this approach, because it pretty much mimics the foreign partnership definition for formal partnerships described above. In other words, while in a formal partnership we look at the place of organization, the governing law approach for deemed partnerships basically looks at the jurisdiction which controls the legal enforcement of the partnership agreement. Both approaches are based on the premise that the foreign partnership definition should depend on whether the partners’ rights and duties are defined under domestic or foreign law.

Foreign Partnership Definition for Deemed Partnerships: Business Location Approach

The primary location of business approach, on the other hand, seeks to classify a deemed partnership not based on where the partners’ rights and duties are defined, but based on where the business of the partnership is actually conducted. The advantage of this approach is that it is closer to business reality and does not artificially classify a partnership based on which law governs it.

There are, however, problems with this approach which make the IRS like it a lot less. First of all, it is very difficult to apply this approach to a partnership with extensive business operations within and outside of the United States. Second, the classification of the same partnership may often switch depending on the shift in the volume of its US operations versus foreign operations.

Contact Sherayzen Law Office for Help With Foreign Partnership Definition

If you are unclear about the classification of your partnership for US tax purposes or you wish to change the existing classification for US tax planning purposes, contact the US international tax law firm of Sherayzen Law Office for professional help. We Can Help You!

Foreign Real Estate US Taxpayer Definition | International Tax Lawyer

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This essay seeks to identify those considered to be a “US Taxpayer” with respect to reporting foreign real estate or income from it to the IRS. In other words, today, I will discuss the foreign real estate US Taxpayer definition.

Foreign Real Estate US Taxpayer Definition: IRC §7701(a)

The definition of “US taxpayer” for the purposes of foreign real estate is equivalent to the definition of US tax resident or “US Person” in IRC §7701(a). “US Persons” are equivalent to “US taxpayers” for the purposes of this article.

Note that, under §7701(a)(1), a person “shall be construed to mean and include an individual, a trust, estate, partnership, association, company or corporation”. In other words, a “person” may mean not only an individual, but also a business entity, trust or estate.

Foreign Real Estate US Taxpayer Definition: General Definition

Under §7701(a)(30), a “US Person” means a US citizen, US resident alien, domestic partnership, domestic corporation, any estate that is not a foreign estate and a trust that satisfies both conditions of §7701(a)(30)(E). Let’s discuss each of these categories of US Persons in more detail.

Foreign Real Estate US Taxpayer Definition: Individuals Who Are US Persons

As I stated above, all US citizens and US resident aliens are considered US Persons. In the vast majority of cases, it is fairly easy to determine who a US citizen is; most complications occur with respect to “accidental Americans” and Americans with only one parent who is a US citizen.

A US resident alien is a more complex term. It includes US Permanent Residents (i.e. “green card” holders) as well as all persons who satisfied the Substantial Presence Test (unless an exception applies) and all persons who declared themselves as US tax residents. This means that a person may be a US resident for tax purposes, but not for immigration purposes. This situation creates a lot of confusion among people who marry US persons or who come to the United States to work; many of them believe themselves to be Non-US Persons, but in reality they are US tax residents.

Foreign Real Estate US Taxpayer Definition: Domestic Corporations & Partnerships

Under §7701(a)(4), corporations and partnerships are considered US Persons if they are created or organized in the United States or under the laws of the United States or any of its states. In the case of partnerships, the IRS may issue regulations that provide otherwise, but the IRS has not done so yet. Conversely, a corporation or a partnership is a Non-US Person if it is not organized in the United States.

Pursuant to §7701(a)(9), the definition of the United States for the purposes of §7701(a)(4) includes only the 50 States and the District of Columbia. In other words, §7701(a)(9) excludes all US territories and possessions from the definition of the United States. For example, a corporation formed in Guam is a Non-US Person!

The biggest complication that one would encounter in this area of law is with respect to common-law partnerships. The determination of their US tax residency may be a lot more complex, because they are not officially organized under the laws of any state.

Foreign Real Estate US Taxpayer Definition: Domestic Trust

A trust is a US Person if it satisfies both tests contained in §7701(a)(30)(E). The first test is a “court test”: a court within the United States must be able to exercise primary supervision administration. The second test is a “control test”: one or more US persons must have the authority to control all substantial decisions of the trust. Failure to meet either test will result in the trust being a Non-US Person with huge implications for US tax purposes.

Foreign Real Estate US Taxpayer Definition: Domestic Estate

While all other definitions described above define a domestic entity and state that a foreign entity is not a domestic one, it is exactly the opposite with estates. Under §7701(a)(30)(D), an estate is a US Person if it is not a foreign estate described in §7701(a)(31).

§7701(a)(31)(A) defines foreign estate as estate “the income of which, from sources without the United States which is not effectively connected with the conduct of a trade or business within the United States, is not includible in gross income under subtitle A”.

Contact Sherayzen Law Office for Professional Help with Your Foreign Real Estate Reporting Obligations in the United States

If you are a US person who owns foreign real estate and you have questions concerning your US tax compliance concerning owning foreign real estate, selling real estate or reporting income generated by foreign real estate, contact Sherayzen Law Office for professional help. We have helped US taxpayers around the world with their foreign real estate US tax obligations, and we can help you!

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Inbound Transactions Tax Framework | US International Tax Lawyer & Attorney

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Inbound transactions deal with Non-US persons who operate in and/or derive income from the United States. This introductory essay opens a series of articles concerning US taxation of inbound transactions. Today, I will set forth the general inbound transactions tax framework; in future articles, I will explore in more detail each element of this framework.

Inbound Transactions Tax Framework: General Guiding Principals

US taxation of inbound transactions is mainly based on the following guiding principle – nexus to the United States. In other words, the US government taxes Non-US persons in a different manner depending on the level and extent of a Non-US person’s activities in the United States.

The more extensive and regular these activities are, the more likely the income derived from these activities to be taxed by the IRS on a net-income basis (as opposed to gross income) at graduated tax rates. On the other hand, if a Non-US person’s activities are limited, less frequent and more passive, then they are likely to be subject to a completely different type of taxation – the one based on gross income at a set rate.

This “US nexus” principal is subject to numerous exceptions due to the fact that the inbound transactions tax framework incorporates two additional goals. The first goal is the US government’s attempt to design the framework in a manner which would attract foreign investments into the United States. For this reason, the Internal Revenue Code (“IRC”) may exclude entire categories of income from US taxation either directly or by altering the source-of-income rules (i.e. excluding certain income from the definition of “US-source income”).

Second, as a counter to the “attraction of foreign investments” principal, the US government wishes to make sure that all income of Non-US persons that needs to be taxed is actually taxed and there is no inappropriate non-taxation of US-source income. As a result of the IRS efforts to ensure the effectiveness of this principal, certain types of income are subject to special regimes of taxation. The most prominent example is the taxation of foreign investments in US real property.

Finally, one should remember to consult US income tax treaties for country-specific exceptions. In particular, treaties often modify tax-withholding provisions with respect to various categories of US-source income.

Inbound Transactions Tax Framework: Main Test

The analytical framework for the taxation of inbound transactions is comprised of a test with seven critical questions. The answers to each question will point us to the right sections of the Internal Revenue Code and establish the correct tax treatment for specific types of income.

  1. Is the person who derives the income is a US person or a Non-US person?

Obviously, if the answer to the question is “US person”, then we are not dealing with an inbound transaction, but a domestic investment. Hence, the taxation of a transaction or investment should be examined under a different tax framework (the one that applies to US persons) than the inbound transactions tax framework.

The difference between these tax frameworks is huge. A US person is subject to worldwide income taxation, whereas a Non-US person is generally taxed only on the income derived from US business activities and US investments.

2. Is it a US-source income?

The question whether a Non-US person derives US-source income or foreign-source income is of huge importance and complexity. The answer to this question involves the analysis of relevant source-of-income rules as modified by a relevant tax treaty.

Generally, Non-US persons are taxed only on their US-source income. This means that if it is determined that the income is derived from a foreign-source, none of it is likely to be subject to US taxation. However, certain types of foreign-source income deemed “effectively connected” with US business activities may still be taxed in the United States. Hence, even if the answer to this question #2 is “no”, you must still continue your analysis by answering question #4 below.

3. Does the Non-US person engage in US trade or business activities?

The determination of whether a Non-US person engages in “trade or business within the United States” depends highly on the facts of a case. In a future article, I will discuss in more detail what the IRS and the courts have determined this term of art to mean.

4. Is the income effectively connected to these US trade or business activities?

The term “effectively connected income” or ECI is one of the most important concepts in US international tax law. It may include not only US-source income generated by a US trade or business, but also certain foreign-source income closely related to a US trade or business. In a future article, I will explore ECI in more detail.

5. Is the ECI subject to a special tax regime such as BEAT or Branch Tax?

The ECI of a foreign person may be subject to a special tax regime related to US companies owned by a foreign person or US branches of a foreign corporation. I will discuss each of these regimes in more detail in the future.

6. If the Non-US person is not engaged in US trade or business activities, is his US-source income classified as FDAP (Fixed, Determinable, Annual or Periodic) income?

FDAP income typically includes passive investment income, such as interest, dividends, rents and royalties. Unless modified by a treaty, FDAP income is subject to a 30% tax withholding on gross income. I will cover FDAP income in more detail in the future.

7. Is this FDAP income subject to an IRC or Treaty Exemption?

In order to promote foreign investment into the United States, certain types of FDAP income are entirely exempted rom US taxation. These exemptions can be found in the IRC or a relevant tax treaty. Again, I will discuss FDAP exemptions in more details in a future article.

Inbound Transactions Tax Framework: Information Returns

In addition to income tax considerations, it is important to remember that the answers to the questions above may lead to the determination of additional compliance requirements in the form of information returns. For example, if a Non-US person engages in a US trade or business through a foreign-owned US corporation, then this corporation may likely have to file Form 5472. A failure to file relevant information returns may lead to an imposition of significant IRS penalties.

Contact Sherayzen Law Office for Professional Help With US Tax Compliance and Planning

If you are a Non-US person who has income from the United States or engages in business activities in the United States, contact Sherayzen Law Office for professional help with your US tax compliance. We have helped hundreds of taxpayers around the world and we can help you!

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Introduction to Corporate Distributions | US Business Tax Law Firm

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This essay opens our new series of articles which focuses on corporate distributions. The new series will cover the classification, statutory structure and tax treatment of various types of corporation distributions, including redemptions of corporate stock. This first article seeks to introduce the readers to the overall US statutory tax structure concerning corporate distributions.

Corporation Distributions: Legal Philosophy for Varying Treatment

In the United States, the tax code provisions with respect to corporate distributions were written based on the belief that stock ownership bestows on its owner an inherent right to determine the right to receive distributions from a corporation.

Generally, a corporation can make distributions from three types of sources. First, a corporation can distribute funds from its accumulated earnings, to be even more precise accumulated Earnings and Profits (E&P). Second, a corporation may also distribute some or all of the invested capital to its shareholders. Finally, in certain circumstances, a corporation may distribute funds or property in excess of invested capital.

Moreover, certain corporate distributions may in reality be made in lieu of other types of transactions, such as payment for services. Additionally, some corporate distributions may be made in the form of stocks in the corporation, which may or may not modify the ownership of the corporation and which may or may not entitle shareholders to additional (perhaps unequal) future distribution of profits.

This varied nature of corporate distributions lays the foundation for their dissimilar tax treatment under the Internal Revenue Code (IRC).

Corporation Distributions: General Treatment under §301

IRC §301 generally governs the tax treatment of corporation distributions. This section classifies these distributions either as dividends, return of capital or capital gain (most likely, long-term capital gain). In a future article, I will discuss §301 in more detail.

Corporation Distributions: Special Case of Stock Dividends

The IRC treats distribution of stock dividends in a different manner than distribution of cash and property. Under §305(a), certain stock distributions are not taxable distributions. However, §305 contains numerous exceptions to this general rule; if any of these exceptions apply, then such stock distributions are governed by §301.

Moreover, additional exceptions to §305(a) are contained in §306. If a stock distribution is classified as a §306 stock, then the disposition of this stock will be treated as ordinary income. In a future article, I will discuss §§305 and 306 in more detail.

Corporation Distributions: Special Case of Stock Redemptions

Stock redemptions is a special kind of a corporate distribution. §317(b) defines redemption of stock as a corporation’s acquisition of “its stock from a shareholder in exchange for property, whether or not the stock so acquired is cancelled, retired, or held as treasury stock.”

§302 governs the tax treatment of stock redemptions. In general, it provides for two potential legal paths of stock redemptions. First, if a stock redemption satisfies any of the four §302(b) tests, then it will be treated as a sales transaction under §1001. Assuming that the redeemed stock satisfied the §1221 definition of a capital asset, the capital gain/loss tax provisions will apply.

On the other hand, if none of the §302(b) tests are met, then the stock redemption will be treated as a corporate distribution under §301. Again, in a future article, I will discuss stock redemptions in more detail.

Corporate Distributions in the Context of US International Tax Law

All of these tax provisions concerning corporate distributions are relevant to US shareholders of foreign corporations. In fact, in the context of US international tax law, these tax sections become even more complex and may have far graver consequences for US shareholders than under purely domestic tax law. These consequences may be in the form of higher tax burden (for example, due to an anti-deferral tax regime such as Subpart F rules) or increased compliance burden (for example, triggering the filing of international information returns such as Form 5471 or Form 926).

A failure to recognize these differences between the application of aforementioned tax provisions in the domestic context from the international one may result in the imposition of severe IRS noncompliance penalties.

Contact Sherayzen Law Office for Professional Tax Help Concerning Corporation Distributions

Sherayzen Law Office is an international tax law firm highly-experienced in US and foreign corporate transactions, including corporate distributions. We have helped our clients around the world not only to engage in proper US tax planning concerning cash, property and stock distributions from US and foreign corporations, but also resolve any prior US tax noncompliance issues (including conducting offshore voluntary disclosures). We can help you!

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