JURISDICTION TO TAX
I. General International Taxation Considerations
A. Capital Flows
i. OUTBOUND: US owned assets abroad are increasing
ii. INBOUND: Assets owned by foreigners in the US are increasing and is greater than Outbound
iii. US are a net importer of the capital and goods, hence à Trade deficit increases.
1. Capital Import Neutrality – all entities subject to the same tax
a. Horizontal Equity – similarly situated entities should be taxed similarly
2. Capital Export Neutrality
a. Do not want to drive business out of US, provide incentive to outsource
3. These theories in case of double taxation cannot coexist: company paying both taxes here and abroad is in disadvantage and violates CIN
4. Also, if give tax breaks then incentivizes other countries to lower their rates
5. Compromise: Generally prefer CEN – tax profits from whatever source derived, but will be congnizant of:
a. Double Taxation
b. Distinguish between kinds of activities abroad
6. Corporation: can form another corporation abroad and thus not be bound to IRC 61, no legal connection, as separate legal entity.
ii. Subpart F: US does not have taxing jurisdiction abroad, however have jurisdiction over a US entity investing abroad as a shareholder in a Controlled Foreign Corporation (CFC), then US will treat you the same as a US shareholder who got dividend by looking at CFC’s income.
1. Exclusions: CIN may apply and US will not tax the profits from abroad.
a. Only if the foreign source money is brought back into the US, it will be taxed.
iii. Double Taxation
1. Domestically Section 164:
a. Provides a deduction for State & Local Income Taxes.
b. If you got a deduction for paying taxes of $100, but that payment made you poorer only by the difference of the $100 and the taxes you would have paid in the absence of such deduction.
c. A Foreign Tax Credit would make one whole (as long as the rates in different countries are the same), while a deduction does not (see above).
II. Residency rules –IRC 7701(b): Safe number – 120 days a YEAR.
A. Goal of the rule is to improve certainty on when a non-Us person must pay taxes.
B. Ways to Become a US Resident (= World Wide Taxation):
i. Green Card
ii. First Year Election
iii. Substantial Presence Test
1. Must be Present in the Us for 183 days for the preceding 2 and the current year
a. Present in the US in the Current year for 31 days, AND
b. Current + Prior 2 = 183
i. Current year day multiplier – 1
ii. 1st Preceding – 1/3
iii. 2nd Preceding – 1/6
2. Partial days count as full days: IRC 7701(b)(7)
3. Residency start on the first day of presence, if SPT met -7701(b)(2)
a. Closer Connection Exception: reg. 301.7701(b)(3)(B)
i. Current year less than 183 days in the US, AND
ii. Individual has tax home in the FC
iii. Tax home in FC = Closer Connection to FC
b. Medical Condition Exception – IRC 7701(3)(D)
i. Physically unable to leave the US, if she is able to prove that the condition arose while she was in the US
ii. Reg. 301.7701(b)-3(c)(3) – if no knowledge of medical condition prior to arrival –e.g. accident, then days do not count; however if intent to get treatment – days count. Key – Intent.
iii. Exclusion of days start after the date for intended presence expires: Reg. 301.7701(b)-3(c)(2)
c. Days in transit less < hours in the US do not count – Reg. 301.7701(b)-3(d) i. Unless individual goes to a business meeting d. Can disregard as not present in the US no more than 10 days IF closer Connection to Another Country (De Minimis Exception) – 7701(b)(2)(C) III. US Citizen Foreign Earned Income Exclusion: IRC 911 A. 911(a) – Exclusion for Gross Income for Citizens and Residents of the US i. Excludes Foreign Earned Income and Housing Allowance, but NOT Capital Income, unless: 1. Capital Income exclusion: 911(d)(2)(b) - when capital is material income-producing factor, allowance for 30% of profits presuming come from personal services & thus are excludable a. When is capital a MATERIAL income-producing factor? Rausku i. Court looks at the proportion of income from capital as related to the personal services income: no fixed number, but look at the manner in which business conducted. ii. Solution: Simply incorporate business and become an EE with a salary – ONE CAN BE IN THE BUSINESS OF BEING AN EE…but the corporate tax than be higher than the foreign income exclusion. 1. But Corporate Tax may be bigger than income tax… 2. IRC 911 (b)(2)(D)(i): Cap of 80K adjusted for inflation 3. IRC 911(c) Housing Cost Amounts a. Not deductible if self-employed. b. Everything else ER-provided excludable subject to 11K floor. i. Housing cost amount for EE housing abroad is a very important compensation consideration. 4. IRC 911(d) – Who qualifies for 911 Exemption? a. Simply having duplicated expenses at home and abroad does not qualify you for 911. b. Citizens: bona fide residence test i. Green Card holders CANNOT use the test ii. Facts & Circumstances Test – Jones (resient because returned Us check from G, lives in ahotel, follows same style as others in his profession do) 1. AND: Must have Tax Home in the FC – 911(d)(3) c. Citizens and Residents: 330 full day test: i. Actual Presence Test: 330 FULL days outside of US. 1. Days are FULL (opposite to 7701(b), where partial days are counted). 2. During ANY 12th month period. 5. Section 911 is an EL
2. Thus, Partnership is involved in US activities and so Partners are as well.
3. Subject to regular US rules
a. Actual distribution does not matter, unlike in Corps.
iii. Choice of Entity Matters:
1. Partnership: US partners are going to be taxed as its earned, without regards to distribution.
2. Corporation: If you qualify for an IRS definition of a corporation – end of matter, cannot choose.
3. If you are a foreign entity and you do not automatically qualify for an IRS definition of Corporation:
a. Then look at whether all members of the entity have limited liability
i. If yes, then the default rule for the “Check the Box” is a Corporation.
ii. If no, the default rule is Partnership.
iii. However, can change the default choice by election – must take action.
VI. The Role of Treaties:
A. If IRC and Treaty is in conflict, the LATER IN TIME CONTROLS
B. Treaties cannot heart you, only help: “Savings clause” – of resident/ citizen of a treaty country – will be taxed as normally would have been taxed US treaty does not affect taxation of US citizen ns/ corporation, only of foreign.
i. Non-Discrimination Provision – person is not treated worse than a U.S. citizen.
C. Taxes Covered:
i. Income TAXES
1. Treaties are Federal, DO NOT cover Sub-National TAXES.
D. Limitations of Benefits provisions in Treaties: if Incorporated entity and people in it outside of the country of incorporation à Treaty does not apply.
E. Modifies Trade or Business Taxation Requirements:
i. Conduct of the Trade or Business in the US is not enough for trigger to be taxed under source country rules: MUST also have Permanent Establishment.
F. Modifies Residency:
i. Tie-Breaker on Residency if a Person has a dual Residency (IRC 7701) (e.g. closer connection to FC and 183 days under SPT in the US): Use next Tie-Breaker is previous one did not give an answer
1. 1st TB: Permanent Home?
2. 2nd TB: Personal and Economic Relations closer?
3. 3rd TB: Habitual Abode?
4. 4th TB: National of Both States = Citizenship?
5. 5th TB: Go to the local taxing authorities if first four tests do not give a definite enough result.
G. Modifies Source Rules
i. Interest: Article 11 may be taxed only by FC
ii. Compensation: Article 14 – income derived by a FC Resident for personal services of independent character shall be taxable only in that State, unless fixed base (office) in the US for the purpose of performing these activities