Nonresident Aliens and Foreign Corporations

Tx 8300

Learning Objectives

1. Identify __________ aliens,

2. Explain rules for taxing foreign persons,

3. Identify ___________ connected income,

4. Explain _____ of attraction rule,

5. Calculate tax ________ of foreign persons, and

6. Determine foreign person’s ________ tax rate from U.S. business profits.

You should be able to:

U.S. Residents and NRAs

• Section 7701(b) does not apply:– Under ______ and ____ tax law– To U.S. ________– When sourcing gain from selling ________

• ___________ rules in U.S. treaties– Apply to ____ residents – _______ §7701(b)

Estate and Gift TaxesSubtitle ___ Estate and Gift Taxes

Income TaxOutbound§_____

Income TaxInbound§______

U.S. Tax System Foreign Tax System

Sourcing Gains§_____

Income TaxOutbound

Income TaxInbound

Dual ResidencyTie-Breaker Rules

(________)

Multiple Residency Regimes

Resident Alien Defined

• ___ U.S. citizen

• U.S. resident– ______ permanent resident– Substantial presence– First ____ election– Nonresident election– ___ resident election

Lawful Permanent Resident

• Requirements– Granted privilege of permanently residing– Privilege not _______ or abandoned

• Residency starting date– First day in U.S. as ______ permanent resident– Assumes substantial presence test ___ met

Substantial Presence Test

• Requirements– U.S. presence in current year ≥ ___ days,– U.S. presence in 3 years ≥ ____ weighted days,

and– __ exceptions apply

• Residency starting date– First day of ____ presence– Ignoring up to ___ days of closer connection to

home country

Exception: Facts and Circumstances

• U.S. presence in current year < ___ days

• Foreign tax ____

• Closer __________ to home country

• Not applying for _____ card

Example: Residency Test

Sean O’Brien, an Irish citizen, does not have a green card, nor has he applied for one. He visited the U.S. for ___ days in 2003, ___ days in 2004, and ___ days in 2005. Dublin is his regular and principal place of business and where his family resides. Sean rents an apartment in Atlanta and banks with Wacovia. However, his primary bank is First Dublin, and his primary social connections are in Dublin. Is Sean a U.S. resident?

Exception: Exempt Person

• Foreign _________ personnel

• Students

• Teachers and ________

• Professional athletes competing in charitable ______ event

Exception: Medical Emergency

• Became sick while visiting ____

• Unable to leave as _________

• Inapplicable to those ______ to U.S. for medical treatment

Exception: Transient

• Regular commuters from ______ and ______

• Brief U.S. layovers when traveling between ________ locations

Exception: Transient

• _______ crew member

• _______ vessel engaged in international commerce

• If individual– Temporarily present in ____ and– Not engaged in ____ trade or business

First Year Election

• Requirements– Not a U.S. resident in _____ year– Meets substantial presence test ____ year– Not a U.S. resident ____ year (without election)– U.S. presence this year ≥ ___ consecutive days– U.S. presence this year ≥ ___% of testing period

• Residency starting date is 1st day of earliest _______ period meeting ___% requirement

Nonresident Election

• Requirements– NRA on ____ day– Married to U.S. individual on ____ day– Each spouse ______

• Election– Continues indefinitely until revocation,

legal separation, or _____ terminates– ___ available again

• Converts ___ to U.S. _______

New Resident Election

• Requirements– ___ on first day, but __ on last day

– Married to ____ individual on last day

– ___ spouse elects

• Election– Continues indefinitely until revocation, legal separation, or

_____ terminates

– ___ available again

• Converts ____ ____ alien to U.S. _______

U.S. Taxation of Foreign Persons

• Effectively connected income (ECI)– _______ tax rates applied to– ________ income

• U.S. source income not EC (____)– ____ rate applied to– _____ income

Taxing Ordinary Income

RegularRatesU.S. Source

Foreign Source

ECI Not ECI

RegularRates

FDAPat 30%

Exempt

FDAP Income

• U.S. source income that is not ___

• Includes mostly __________ income

• Prizes, ______, and gambling income

• Alimony

• Gain from selling intangibles when payments are __________

• ___% of Social Security benefits

Example: Social Security Benefits

The U.S.-France totalization agreement entitles a French national and resident to a $1,000 Social Security benefit. How much should the U.S. Social Security Administration withhold?

Example: Social Security Benefits

The U.S.-Germany totalization agreement entitles a German national and resident to a $1,000 Social Security benefit. The U.S.-Germany income tax treaty allows only the country of residence to tax Social Security benefits. How much should the U.S. Social Security Administration withhold?

Withholding on Foreign Persons

Dependent personal services Estimated __________ based on likely tax liability

Independent personal services

Most FDAP income

Estimated __________ based on 30% or lower treaty rate

_____ tax based on 30% or lower treaty rate

Failure to Withhold

• Withholding agent is ____ ____ person with custody and control

• Failure to withhold causes ____ _____ to be liable for tax, interest, and penalties

Taxing U.S. Source Capital Gain

RegularRatesNRA < 183 days

Foreign Corp

ECI Not ECI

NRA ≥ 183 days RegularRates

RegularRates

30%

ECI: Salient Issues

• Is the activity a U.S. trade or business?

• Is income effectively connected with the U.S. trade or business?– When is ____ source income ECI?– When is _______ source income ECI?

Trade or Business Defined

• Considerable, _________, and regular activity conducted for ______

• If a partnership engages in a U.S. trade or business, _______ partners are engaged also.

• ____ rendering personal services in the U.S. usually are engaged in a U.S. trade or business.

De Minimis Rule

NRA rendering services in U.S. is not engaged in a U.S. trade or business if– Compensation ≤ ______,– U.S. presence ≤ ___ days, and– Services rendered for either

• Foreign person ___ _______ in U.S. trade or business or

• Foreign place of business ____ person maintains

Trade or Business Examples

• _______ sales to U.S. customers via _________ agent

• Selling items in U.S. via employees with power to ________

• Certain single events

Non-Trade or Business Examples

• Mere _____________

• Mere ___________ of passive income

• Mere ________ of stock or real estate

• Mere _____________ of business opportunities

• Mere _______ of goods in U.S. for export

• ______ sales without using employees, agents, or office in U.S.

“Effectively Connected” in General

• Trade or business is a ___________ to ECI

• Several exceptions apply

• ____ of ___________ rule

• Criteria for determining ECI depend on the income’s ______

ECI without U.S. Trade or Business

• Elect to treat real property income as ___

• _________ income of possession banks from ____ obligations

• Gain from selling ____ real property interest

• Deferred receipts from _____-year business

• ____ from selling property within __ years U.S. business use

Residual Force of Attraction

• When a foreign person engages in a ____ trade or business

• All ____ ______ income other than– FDAP income,– Income specifically excluded, and– Capital gain

• Is treated as ___

Example: Force of Attraction

ManufacturerSales

Branch

U.S. TitlePassage

Result:

Solution:

DirectSale

Is It ECI?

• If U.S. source income– _____ use test– Business __________ test

• If foreign source income, it must be attributable to a U.S. _____ to be ECI.

U.S. Source Income as ECI

• Asset use test– Was the income derived from assets ________

used or held for ______ use in a U.S. trade or business?

– Is interest income from the assets below ECI?

Trade receivables

Temporary investment of idle working capital in U.S. T-bills

Long-term investment of excess capital in U.S. T-bills for future product lines

U.S. Source Income as ECI

• Business activities test– Were activities of U.S. trade or business a

________ factor in realizing the income?– Are the income items below ECI?

Fees a service business earns

Interest income of a financing business

Premiums of an insurance company

Royalties of a business that primarily licenses intangibles

Dividends of a dealer in stocks and securities

Foreign Source Income as ECI

Pre-1966 Historical PerspectiveFC

SalesOffice

Customer

Sells inventory

Foreign Source Income as ECI

• FSI usually is not ___

• ECI only if– Foreign person has ____ office that is– _________ factor in earning FSI and regularly used– To earn

• Royalties from using intangibles ______

• Dividends or _______ in financing or securities business

• Inventory profit when _____ passes abroad

Foreign Source Income as ECI

FC

U.S.Office

Licensee

Licenses Technology for Use Abroad

Foreign Source Income as ECI

FC

SalesOffice

Customer

Sells inventory

In effect, inventory profit of a U.S. office is:(i) USSI that is ___ or(ii) FSI that is not ___.

Exclusions

• Attracting Capital– Interest on _________– Dividends from some ____– __________ interest

• Facilitating Business– International ______________ income– _________ exchange or training-related

income– Certain _________ income

Exclusions Attracting Capital

• Interest on ________ with banks, S&Ls, and insurance companies if not ___

• Dividends from ___ meeting ___% active foreign business test times DC’s percentage of gross income that is ___

Exclusions Attracting Capital

• Most nations exempt interest on debt in the _________ market

• U.S. persons had difficulty raising capital in _________ market

• Congress enacted §______ in 1984• Excludes interest income foreign

persons owning < ___% of U.S. debtor receives from debtor’s __________

Example: Bank Deposit

Awni is an Egyptian national and resident. He buys a C.D. from a U.S. bank and earns $37,000 interest. Does the U.S. tax this interest? Why or why not?

Example: Dividend from DC

Sophia, a Greek citizen and resident, receives $70,000 dividends from a U.S. company. How much of her dividends should she report as gross income?

Exclusions Facilitating Business

• International transportation income if person’s home country ___________

• Income NRAs receive from foreign employers while temporarily in U.S. for _______ or cultural exchange

• _______ income from blackjack, baccarat, craps, roulette, big-6 wheel, and certain pari-mutuel bets

Deductions Allowed

• Expenses related to ECI– State and local income tax paid on ___– Expenses of employment _____ to ____– Unreimbursed _______ expenses

• Three personal expenses– Personal _______ loss for property in ____– _________ contribution– ___ personal exemption

No Deductions Allowed

• Other personal expenses– ____ mortgage interest– Property tax on ________– ______ expenses– _______ deduction

• Expenses related to ____ income

Tax Rates for NRAs

Single Single schedule

Head of household

Married

_____ schedule

Married filing _______ schedule

Married to U.S. person and making ___ resident or ___________ election

Married filing joint schedule

_________ spouse if home country is Canada, Japan, Korea, or Mexico

Married filing _____ schedule

Credits

• Foreign persons are eligible for most credits under U.S. law

• FTC can only offset U.S. tax imposed on ___

Tax Computation for NRA_____ incomeU.S. capital gains (not ____)

- U.S. capital losses (___ carryovers) Gross income (other than ___)

x ___% (or lower treaty rate)

Effectively connected income- Deductions for AGI related to ___

Adjusted gross income- Employee expenses related to ___- State and local ______ tax related to ECI- Personal casualty loss (if ____ property)- Charitable contribution- ___ personal exemption

Taxable ___x Graduated rates

U.S. tax on ____ and capital gain

+ U.S. tax on ___ U.S. tax before credits

- Credits, prepayments, withholdingsU.S. tax liability

Marginal Tax Rates

MTR = tus + tdiv (1 - tus)

MTR =

ForeignParent

Profit $1,000U.S. tax - 350E&P $ 650

U.S.Sub

Marginal Tax Rates

ForeignParent

Profit $1,000U.S. tax - 350E&P $ 650

U.S.Sub

Now assume the same situation except the dividend occurs 5

years later and the appropriate discount rate is 9%.

€

MTR = tus + tdiv (1 - tus)(1 + d)y

Example: Marginal Tax Rate

An Italian company owns all the stock of Domco. Domco earns $________ and currently remits all after-tax profits as a dividend. Assume a 35% U.S. effective tax rate. The U.S.-Italy income tax treaty specifies a dividend withholding rate of __%. Italy does not tax the dividend. What is the marginal tax rate on the U.S. profit?

MTR = tus + tdiv (1 - tus)

MTR =

Example: Marginal Tax Rate

An Italian company owns all the stock of Domco. Domco earns $________ and expects to remit all after-tax profits as a dividend in ten years. Assume a 35% U.S. effective tax rate and a 9% discount rate. The U.S.-Italy income tax treaty specifies a dividend withholding rate of __%. Italy does not tax the dividend. What is the marginal tax rate on the U.S. profit?

€

MTR = tus + tdiv (1 - tus)(1 + d)y

Example: Marginal Tax Rate

An Italian company owns all the stock of Domco. Domco currently remits all its profits as deductible interest. Assume a 35% U.S. effective tax rate. The U.S.-Italy income tax treaty specifies an interest withholding rate of ___%. Italy may impose a residual tax. What is the marginal tax rate on the U.S. profit before considering the Italian income tax?

MTR = tint

MTR =

Anti-Siphoning Rules

• ____ capitalization rules require a reasonable debt-to-equity ratio

• Interest ________ rules disallow deductions

• Some countries keep interest and royalty withholding rates ____

Branch Profits TaxPre-1987 Historical Perspective

Branch

FC

Sub

Profit $1,000U.S. tax - 350

$ 650

BPT Achieves Parity

FC’s effectively connected ____

- Increases in FC’s U.S. net _____

+ Decreases in FC’s U.S. net ____

________ equivalent amount

x __% or lower treaty rate

Branch profits tax

Example: Branch Profits Tax

Forco earns $___ ECI. Assuming U.S. operations remit half of their after-tax earnings and a 35% U.S. tax rate, should Forco structure its U.S. operations as a branch or subsidiary? How much profit does Forco receive under each structure?

U.S. Subsidiary U.S. Branch

ECIU.S. income taxE&P or after-tax profits

Dividend or DEAU.S. withholdingRemittance

$400 $400