Part I – Overview
I. Overview: course is on how we tax trans-national transactions
A.Legal Authorities: Code, Regs, Treaty – start w/ Code – ask if Treaty modifies anything – all treaties bilateral. Mostly w/ Japan & European Cs – almost none in Africa; handful in Latin America (first was Venezuela – oil).
B. Trends in Int’l Cash Flows: outbound and inbound investments are going up; b/ inbound side is increasing more steadily and faster; this is b/c US is a net importer of capital & goods
C.Capital Import Neutrality & Capital Export Neutrality: essentially mutually exclusive
Capital Import Neutrality (CIN).
Capital Export Neutrality (CEN).
Equality: horizontal equity, ie similarly situated people/corp should be taxed similarly. Idea is two firms in Country X should get taxed the same. Country Y shouldn’t add on more tax to a firm that happens to be domiciled in Country Y. US doesn’t follow to the most part. We are afraid of race to the bottom – every other country will just make their tax a little bit lower than ours.
Single taxing authority determined by income source avoids double taxation: Method says if Firm 1 is domiciled in Country Y b/ operates & earns income in Country X – only Country X taxes that income
Gov’t doesn’t want corp to go to other countries and invest, ie drive income out of the US. As a result, we want horizontal equity among all US taxpayers regardless of their source of income.
D.Mitigating Double Tax – Usually via a Credit system: US gives Foreign Tax Credit. For taxes paid on some types of income (active) we provide deferral; for passive we tax immediately.
1. Credits only way to eliminate double tax w/ CEN – deductions aren’t free: The value of a deduction is always exactly equal to your marginal tax rate. If I got a deduction for paying taxes of $100 to another authority then I saved myself $35 in taxes (if the tax rate was 35%) but I haven’t saved myself $100 in taxes. Hence, a mere deduction never makes you whole.
a. Capital Import Neutrality Method – I earned the $100 abroad. Country A (my domicile) doesn’t tax it. Country B (the source) charges me $15, i.e. it’s 15% tax rate.
b. Capital Export Neutrality w/ Tax Credits to mitigate – I pay the $15 to Country B. Country A has a tax rate of 25% & assesses my tax burden at $25. I get a $15 tax credit and end up with a total tax liability to Country A of $10. Thus, I pay the same amount of tax, i.e. $25, which I would have paid if I had produced the income in Country A.
c. Capital Export Neutrality w/ Deductions to mitigate – I pay the $15 to Country B. I now deduct $15 from my gross income on my Country A tax return, leaving me with $85 of taxable income. I have $85 of income. I pay a 25% rate on it. I pay $21.25 in tax to Country A. My total tax burden was $36.25. This is $11.25 higher than what we saw
2. US allows deferral on active foreign income: b/ Choice of Entity is key – Sub can get deferral; Branch doesn’t. No deferral on passive income.
E.Two main categories of Transactions – Inbound and Outbound: For inbound – we ask how we tax foreign transactions that are happening in the US. Principles of international comity and administrative problems affect where and who we tax. For outbound – ask how we tax the US person who earns income outside the US
Part II – Jurisdiction to Tax
I. Jurisdiction to Tax
A. US Citizens taxed on worldwide income: See Cook v. Tait (S. Ct. 1924) (U.S. citizen permanently residing in Mexico has to pay US tax). A gov’t by its very nature benefits the citizen & his property wherever found
1. Comity issues: we don’t care that you might be taxed 2 times by 2 countries; it’s your choice; you went to Italy. The Foreign Tax Credit mitigates double taxation (b/ if Italy’s rate is lower you have to pay US the balance – Capital Export Neutrality)
2.Policy debate – should we tax so differently from our competitors? Most other developed countries have territorial taxation – Capital Import Neutrality
B.Resident Aliens – generally treated same as US Citizen: Person is resident alien if they are a permanent resident (green card test) or if they meet the substantial presence test. See IRC 7701(b)(i) & (ii). We don’t go by your official immigration status – for tax purposes we have our own categorization process
(1) Are they a Resident Alien under the green card test? If Yes, they are definitely a Resident Alien without exception. If No, move onto Substantial Presence Test.
(2) If no – are they a Resident Alien under the Substantial Presence Test? If No, then they are a non-resident Alien. If Yes – move onto Closer Connection test.
(3) If person met the Substantial Presence test, but was here less than 183 days in the Current Taxable Year – do they pass the Closer Connection Test? If Yes, they are considered a non-resident alien this year. If no, they are stuck being taxed as a Resident Alien.
1. Permanent Resident, aka Green Card Test: easy – see 7701(b)(1)(A)(i) – is person admitted as a lawful permanent resident at any time during current calendar year? If yes – they are a US Resident.
2. Substantial Presence Test: 7701(b)(1)(A)(ii) directs us to test of 7701(b)(3).
Basic Requirement – 2 Prongs (current year prong and 3 year prong)
(1) Current taxable year – 31 days: person spent at least 31 days in the US AND
(2) During current taxable year plus 2 preceding calendar years – 183 days: person spent atleast 183 days in the US during these 3 years. See 7701(b)(3)(A)(i) and (ii) (language says equals or exceeds 183 days). But see formula on counting days in preceding years below!
*** Presence for any part of 1 day counts as a full day: 301.7701(b)-1(c)(2)(i) as long as you are physically present in the US for any time during the day – it counts as a day
a. Special Formula for counting the days in the 2 prior years:
Immediately Preceding Year
Next Prior Year
1 day = 1/3 of a day
1 day = 1/6 of a day
Table 7701(b)(3)(A)(ii) – Policy seems to mitigate unintentional “opting in”
b. Certain Days Excluded from the measurement: for policy reasons
i. Peron was an exempt individual on such day: 7701(b)(3)(D)(i) – look at Reg. 301.7701(b)-3(b)(1) for list.
(i) Foreign Gov’t related individual as defined by (b)(2)
(ii) Teacher or trainee as defined by (b)(3)
(iii) Student as defined in (b)(4)
(iv) Professional athlete as defined in (b)(5)
ii. Medical condition: person was unable to leave US on such day b/c of a medical condition which arose while individual was present in US; 7701(b)(3)(D)(ii). B/ if P had medical condition before arriving in US and was aware of it, day will count – Reg. 1.301-7701(b)-3(c). Policy – if you come here for treatment those days count – different from vacationer who gets sick.
Reasonable # days to make arrangements to leave:Reg. 301.7701-3(c)(1)
Only exclude days where P didn’t intend to be in US: Reg. 301.7701-3(c)(4)
iii. Days in transit: Reg. 7701-(b)-3(d) have to be in US for less than 24 hours & cannot attend business meeting of any kind – not clear if family visit is okay.
c. Closer Connection Test if you were present less than ½ the year (183 days) THIS year: see 7701(b)(3)(B)(i) – (ii): note – if you are here in the current year more than half the year you would be a resident unless some of those days are excluded under the exception rules
ii.Step One: make sure person was present less than 183 days of the current yr(i)
iii. Step Two – prove person has tax home in foreign country: as defined in 911(d)(3) – leads you to 162(a)(2). Follow Reg. 301.7701(b)-2(c)(1) – (2). Per Abreu – we can’t litigate this like persons can do under 162(a)(2) – b/c here it’s not just the IRS’s position – it’s actually in the regs – means great deference; it’s difficult to invalidate a reg. “Thus, an individual’s tax home is considered to be located at the individual’s regular or principal (if more than one regular) place of business. If the individual has no regular or principal place of business, (or has no business at all) then the tax home is the regular place of abode in the real and substantial sense).
Under (c)(2) Reg. theymust maintain the home for the entire year and the tax home must be in the same foreign country that the individual is claiming to have a closer connection to.
iii. Step Three – prove closer connection to a foreign country: see Reg. 301.7701(b)-2(d)(1) listing factors in (i) – (x).
***Example: see Problem 2 on page 42
3. Special Rules for First Year of Residency (When it begins and when it ends) 7701(b)(2)(A)
a. General Rule – In 1st Year of Residency – Taxing begins on Your Residency Starting Date: so we bifurcate the year. If you are a resident starting March 15th we tax you starting on that day. 7701(b)(2)(A)(i)
b. Residency Start Date Where Alien Meets Green Card Test: Residency starting date is the first day during the calendar year in which the individual is physically present in the US as a lawful permanent resident. Example – in 2005 Y becomes US Lawful Resident on March 15th but he is in Germany when he obtains that status. Y arrives in US physically on March 18th. March 18th is the Residency start date. 7701(b)(2)(A)(ii) & Reg. 301.7701(b)-4(a)
c. Residency Start Date Where Alien Meets Substantial Presence Test: residency start date is the first day during such calendar year on which the individual is treated as a resident of the US under that paragraph. So if you meet the Substantial Presence test on April 2nd, that will be your Residency start date. 7701(b)(2)(A)(iii) & Reg. 301.7701(b)-4(a)
d.Residency Start Date Where Alien Meets Green Card & Substantial Presence Test: residency start date is the earlier of (1) the first day the individual is present in US as Lawful Permanent Resident or (2) the first day during the year that the individual is present for purposes of the Substantial Presence Test
4. Special Rules for Last Year of Residency – 7701(b)(2)(B): the default is to count the entire last year where you were a Resident (even if you ceased to be a resident part way through) unless a three prong test can be met.
Three Prong test to be able to bifurcate the last year
(1) Portion you want to discount is after last day in calendar year that person was present in US or last day person was Lawful Permanent Alien: 7701(b)(2)(B)(i)
(2) Closer Connection is established for this portion: you have to show that during this portion after person was no longer present in US or was no longer a Lawful Perm
ne –Tax Home – 911(d)(3) & 1.911-2(b): same as in 162(a)(2) –regular or principal place of business; if no regular place of business – regular place of abode in real & substantial sense.
a. Maintenance of dwelling place in US is not a killer: even if it is used by spouse/dependents doesn’t necessarily mean individual’s abode is in the US. 1.911-2(b) & Jones
b.“Abode” in the US is a killer:even if your regular or principal place of business is in a foreign country, if your “abode is in the US” you will not “be considered to have a tax home in a foreign country” for that period. See 911(d)(3) – statutory authority – 1.911-2(b)
i. Policy: stop person living on US/Canada border from claiming Canada tax home
ii. Defining Abode –facts and circumstances test:similar factors from our “bona fide” resident test; only now they are being looked at to see whether he had his abode there.
2. Prong Two via the Bona Fide Residence – Available to US Citizens only:
a. Automatic Failure under 911(d)(5) Test (Inconsistent w/ Dif. Countries): if the (A) individual who has earned income from sources within the foreign country submits statement to the authorities of the foreign country that he is not a resident of the country and (B) the individual is held not subject as a resident of that country to the income tax of that country by its authorities with respect to such earnings.
b. Otherwise use facts & circumstances test: see Jones about Japanese Pilot. Factors on 427 of casebook. Per Abreu pre-7701(b) this is the same kind of test we had to determine if you were a US resident. We still use it for this purpose.
(1) Intention of the TP
(2) Establishment of his home temporarily in the foreign country for an indefinite period of time
(3) Participation in the activities on social and cultural levels, identification w/ the daily lives of the people & assimilation into the foreign environment
(4) Physical presence in the foreign country consistent w/ his employment
(5) Nature/duration of his employment; whether his assignment abroad could be promptly accomplished w/I a definite or specified time; or
(6) Assumption of economic burdens and payment of taxes to the foreign country;(7) Status of resident contrasted to that of transient or sojourner
(8) Treatment accorded to his income tax status by his employer
(9) Marital status and residence of his family
(10) Nature/duration of his employment; whether his assignment abroad could be promptly accomplished w/I a definite or specified time
(11) Good faith in making his trip abroad; whether for a purpose of tax evasion
***Most Important facts in Jones: (1) turned away Alaskan fund $$$; (2) taxed in Japan; (3) living in the hotel was common practice & most economical; (4) wife had a right to pursue career. The lower court was upset about Hotel & his wife living in US
c.Reg. 1.911-2(c) Determination of bona fide residence: use principles of 871and regs that relate to determining an alien’s residence. Bona fide residence for an uninterrupted period may be established, even if temporary visits are made during the period to the US or elsewhere on vacation or business.
d.Intent of TP: Courts have held that to be a bona fide resident rather than a transient or sojourner, in a foreign country, the TP’s intent to stay must either be indefinite or in connection w/ performance of a project requiring an extended stay. TP who moves abroad for a specific purpose w/ short, fixed time period probably fails bona fide residence test.
4. Prong Two via Physical Presence Test – Available to US Citizens and US Resident Aliens:
a. 12 month test – 1.911-2(d)(1): a period of 12 consecutive months may begin w/ any day but must end on the day before the corresponding day in the 12th succeeding month. The 12 month period may begin before or after arrival in a foreign country and may end before or after departure.
b.330 Day Test – 1.911-2(d)(2): The full 330 full days need not be consecutive but may be interrupted by periods during which individual is not present in a foreign country.
i. Aggregation: In computing the 330 days, all separate periods of such presence during the period of 12 consecutive months are aggregated.