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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!

Contact Us Today to Schedule Your Confidential Consultation!

2017 Tax Reform Seminar | U.S. International Tax Lawyer & Attorney

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On April 19, 2018, Mr. Eugene Sherayzen, an international tax lawyer, co-presented with an attorney from KPMG at a seminar entitled “The 2017 U.S. Tax Reform: Seeking Economic Growth through Tax Policy in Politically Risky Times” (the “2017 Tax Reform Seminar”). This seminar formed part of the 2018 International Business Law Institute organized by the International Business Law Section of the Minnesota State Bar Association.

The 2017 Tax Reform Seminar discussed, in a general manner, the main changes made by the 2017 Tax Cuts and Jobs Act to the U.S. international tax law. Mr. Sherayzen’s part of the presentation focused on two areas: the Subpart F rules and the FDII regime.

Mr. Sherayzen provided a broad overview of the Subpart F rules, the types of income subject to these rules and the main exceptions to the Subpart F regime. He emphasized that the tax reform did not repeal the Subpart F rules, but augmented them with the GILTI regime (the discussion of GILTI was done by the KPMG attorney during the same 2017 Tax Reform Seminar).

Then, Mr. Sherayzen turned to the second part of his presentation during the 2017 Tax Reform Seminar – the Foreign Derived Intangible Income or FDII. After reviewing the history of several tax regimes prior to the FDII, the tax attorney concluded that the nature of the current FDII regime is one of subsidy. In essence, FDII allows a US corporation to reduce its corporate income by 37.5% of the qualified “foreign derived” income (after the year 2025, the percentage will go down to 21.875%). Mr. Sherayzen explained that, in certain cases, there is an additional limitation on the FDII deduction.

Qualifying income includes: sales to a foreign person for foreign use, dispositions of property to foreign persons for foreign use, leases and licenses to foreign persons for foreign use and services provided to a foreign person. There are also a number exceptions to qualifying income.

Mr. Sherayzen concluded his presentation at the 2017 Tax Reform Seminar with a discussion of the reaction that FDII produced in other countries. In general this reaction was not favorable; China and the EU even threatened to sue the United States over what they believed to be an illegal subsidy to US corporations.

EU Market Entry Seminar | US International Tax Lawyer & Attorney

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On February 8, 2018, Mr. Eugene Sherayzen, an international tax lawyer, co-presented with three other attorneys in a seminar titled “EU Market Entry: Business and Tax Considerations” (the “EU Market Entry” seminar). The EU Market Entry Seminar was co-sponsored by the Business Law Section and International Business Law Section of the Minnesota State Bar Association. The three other speakers were a business lawyer from Germany, a tax lawyer from Lithuania and a business lawyer from the United States.

Mr. Sherayzen began his part of the EU Market Entry Seminar with the explanation of the main purpose of tax planning. He asserted that tax planning should not be done only to reduce costs, but to maximize the real profits of a business transaction.

Then, the tax attorney proceeded with the explanation of the main international tax planning strategies with respect to outbound business transactions. In particular, he discussed in detail the following strategies: (1) overseas profit tax reduction; (2) U.S. tax deferral; and (3) Prevention of double-taxation. Each of these strategies was accompanied by three to four relevant tactics. The tax attorney focused especially on U.S. tax deferral as the “heart” of the U.S. tax planning.

The next part of the EU Market Entry Seminar was devoted to the classification of international business transactions. Mr. Sherayzen grouped different types of international business transactions into three categories: (1) Export of Goods and Services; (2) Licensing & Technology Transfers; and (3) Foreign Investment Transactions (including Foreign Direct Investment and Foreign Portfolio Investment).

The final part of the EU Market Entry Seminar consisted of applying the aforementioned tax strategies to each of the three groups of international business transactions and determining which strategies were likely to perform better than others with respect to a particular group of international business transactions. For example, Mr. Sherayzen stated that overseas profit tax reduction and prevention of double-taxation were easier to implement for international business transactions that involved export of goods or services; the U.S. tax deferral would be much more difficult to implement in this context and it would require extensive tax planning.

Mr. Sherayzen concluded the EU Market Entry Seminar with an introduction to the audience the concepts of GILTI (Global Intangible Low-Tax Income), BEPS (Base Erosion and Profit Shifting) rules, CbC (country-by-country) reporting and FDII (Foreign Derived Intangibles Income). These concepts were integrated within the discussion of the effectiveness of certain tax strategies with respect to the second and third categories of international business transactions. For example, the tax attorney discussed how the new GILTI rules affect the ability to achieve U.S. tax deferral.

FACC Seminar (French-American Chamber of Commerce Seminar) | News

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On October 19, 2017, Mr. Eugene Sherayzen, an owner of Sherayzen Law Office and a highly experienced international tax attorney, conducted a seminar titled “Introduction to U.S. International Tax Compliance for U.S. Owners of Foreign Businesses” at the French-American Chamber of Commerce in Minneapolis, Minnesota (the “FACC Seminar”). The audience of the FACC Seminar consisted of business lawyers and business owners.

The FACC Seminar commenced with the breakdown of the title of the seminar into various parts. Mr. Sherayzen first analyzed the tax definition of “owner” and contrasted it with the legal definition of owner. Then, he identified who is considered to be a “U.S. owner” under the U.S. international tax law.

During the second part of the FACC Seminar, Mr. Sherayzen discussed the definition of “foreign” (i.e. foreign business) and the definition of the concept of “business”, contrasting it with a foreign trust. At this point, the tax attorney also acquainted the attendees with the differences between the common-law and the civil-law definitions of partnership.

Then, the focus of the FACC Seminar shifted to the discussion of the U.S. international tax requirements. The tax attorney stated that he would discuss four major categories of U.S. international tax requirements: (1) U.S. tax reporting requirements related to ownership of a foreign business; (2) U.S. owner’s tax reporting requirements related to assets owned by a foreign business; (3) U.S. tax reporting requirements related to transactions between a foreign business and its U.S. owners; and (4) income recognition as a result of anti-deferral regimes.

Mr. Sherayzen first discussed the U.S. tax reporting requirement related to the ownership of a foreign business. In particular, he covered Forms 5471, 8865 and 8858. The tax attorney also introduced the catch-all Form 8938. In this context, he also explained the second category of U.S. international tax requirements concerning the assets owned by a foreign business.

The next part of the FACC Seminar was devoted to the U.S. tax reporting requirements concerning transactions between a foreign business and its U.S. owners. Mr. Sherayzen explained in detail Form 926 and Schedule O of Form 8865, including the noncompliance penalties associated with these forms. The tax attorney also quickly reviewed Form 8886 for participating in transactions related to tax shelters. The discussion of the complex penalty system of Form 8886 surprised the audience.

The last part of the FACC Seminar was devoted to the income tax recognition and other U.S. tax reporting requirements that arise by the operation of anti-deferral regimes. Both, the Subpart F and the PFIC regimes were covered by the tax attorney.

NPB Neue Privat Bank Signs Non-Prosecution Agreement | OVDP Lawyer

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On July 18, 2018, the US Department of Justice (the “DOJ”) announced that it signed a Non-Prosecution Agreement with NPB Neue Privat Bank AG (“NPB”). Let’s explore in more detail the history of this case and its resolution.

Background Information: 2001 QI Agreement between NPB and the IRS

NPB is a Swiss private bank based in Zurich. In 2001, NPB entered into a Qualified Intermediary Agreement (“QI Agreement”) with the IRS, which had extensive requirements for US tax withholding and US information reporting. Among these requirements was the obligation for NPB to ask its new and existing US clients to complete IRS Forms W-9 if they engaged in US securities transactions. In such cases, NPB was required to report the relevant transactions on IRS Form 1099.

Based on the QI Agreement, NPB arrived at a paradoxical conclusion that became prevalent among Swiss banks in the early 2000s. It believed that, as long as the bank complied with its QI Agreement, it could continue to accept and service US taxpayers even if NPB knew or had reason to believe that these taxpayers engaged in tax evasion. In other words, the bank could service such clients as long as they were not trading US-based securities or the investment accounts were nominally structured in the name of a foreign-based entity. It does not appear that an opinion of a legal counsel was secured in support for this belief.

Background Information 2009: NPB Accepts Noncompliant US Taxpayers

Prior to 2009, NPB had relatively few US clients; in fact, at the close of 2008, all of the NPB accounts owned by its US clients held approximately 8 million Swiss francs in assets.

The situation changed dramatically in 2009. As a result of the UBS case and other signs of increased IRS activity with respect to undisclosed foreign accounts, major Swiss banks started closing accounts owned by US taxpayers, creating a flood of potential clients for NPB. In early 2009, certain external-asset managers asked the bank to give refuge to these taxpayers and their money. The managers told the bank that they asked their US clients to become tax compliant, but some of them still had not done so.

On March 9, 2009, the NPB’s board of directors unanimously voted to allow US taxpayers to open accounts with the bank, even for those clients who fled other Swiss banks. As a result, by the end of 2009, NPB accumulated close to 450 million Swiss francs in accounts owned or beneficially owned by US taxpayers. The DOJ estimated that only 69% of these assets were reported to the US government at that time.

It appears that the bank’s executives had hoped that their US clients would eventually come into full compliance with US tax laws, but no written or formal policy to encourage or mandate such compliance was ever created.

Years 2010-2012: NPB Stops Accepting US Clients and Implements Some Procedures to Encourage US Tax Compliance

In August of 2010, as a result of the fact that US tax enforcement made the environment for Swiss banks which accepted noncompliant US taxpayers more and more dangerous, NPB decided not to open any new accounts for US clients who were noncompliant with US tax laws.

This decision (which was not reduced to writing) did not stop the bank from continuing to service its already existing noncompliant US taxpayers. Moreover there were at least 89 US-related accounts, both declared and undeclared, held in the name of offshore structures, such as trusts or corporations. These offshore structures were domiciled in countries such as Panama, Liechtenstein, the British Virgin Islands, Hong Kong, and Belize. All of these structures, however, were set up before the clients were accepted by the bank.

Starting August of 2010, NPB finally started to require new US clients to provide Forms W-9. The existing clients were required to submit Form W-9 only starting in the summer of 2011. The bank started to require evidence of tax compliance from its external asset managers only in August of 2011.

Swiss Bank Program: NPB is a Category 1 Bank

On August 29, 2013, the DOJ announced the Swiss Bank Program, but it declared NPB as a Category 1 bank ineligible to participate in the Program. By that time, the DOJ already started its investigation of the bank and its activities with respect to noncompliant US taxpayers.

Non-Prosecution Agreement with the DOJ

NPB cooperated throughout the DOJ investigation. In fact, the bank turned over the identities of US account holders and beneficial owners of more than 88% of the US-held assets.

The parties finally reached the agreement on July 18, 2018, when they signed the Non-Prosecution Agreement. Under the Agreement, the DOJ promised not to prosecute NPB. In return, the bank agreed to pay a penalty of $5 million. The bank further agreed to cooperate in any related criminal or civil proceedings as well as demonstrate that it implemented the necessary procedure to stop misconduct involving undeclared US-related accounts.

Contact Sherayzen Law Office for Help With the Voluntary Disclosure of Your Foreign Accounts

The NPB-DOJ Non-Prosecution Agreement demonstrates the continued IRS focus on US international tax enforcement. The IRS has devoted considerable resources to this area and all noncompliant US taxpayers around the world are at a significant risk of discovery, not just taxpayers with undisclosed Swiss bank accounts.

If you have undisclosed foreign accounts, contact Sherayzen Law Office as soon as possible to explore your voluntary disclosure options. Time is of the essence: the IRS flagship Offshore Voluntary Disclosure Program (“OVDP”) will close on September 28, 2018.

Contact Us Today to Schedule Your Confidential Consultation!