International Taxation of Businesses

Most of the time, taxpayers and the source of income are both domestic. International taxation applies if there is a difference in location between the taxpayer and the source of the income.

Tax Treaties

Tax treaties have equal authority as the international revenue code. However, if there is a distinction between the IRC and a tax treaty, the tax treaty is typically more likely to apply. In those situations, the taxpayer would need to attach Form 8833, informing the IRS that the texpayer is utilizing the benefit of the treaty.

Things that will Caus a Business to be Taxed Internationally

1. Ship to a foreign (out of country) location
2. License a foreign company to service the foreign market
3. Maintaining a foreign branch or location
4. Create a subsidiary in a foreign location

Currency

Any tax returns filed in the United States will be based on U.S. dollars (even if goods or services sold in a foreign country are sold with a different type of currency). So, any revenue obtained in a foreign county must be converted to the United States currency at the time when the gain or loss was made.

Determining Domestic v. Foreign Sources of Income

An important note to make is that for the United States, taxpayers are taxed on income derived, no matter where the source of income was generated geographically.

There are several general rules and exceptions to follow:

• Interest: If a U.S. entity is paying the interest, then the source is derived from the U.S. However, if the interest payer generated 80% or more of its income from outside the U.S. over the past three years, then the source is foreign.
• Dividends: If a U.S. entity is paying the dividend, then the source is derived from the U.S. If a foreign entity is paying the dividend, then the source is derived from the foreign location. However, if 25% or more of the income is derived from U.S. business activity for the prior 3 years, any corresponding percentage (not all of it) is deemed to be a U.S. source. (This doesn’t matter for U.S. citizens but matters greatly for foreign tax payers).
• Rents and Royalties: The source of income derived is based on the lcation and use of the property.
• Personal Services: The source of income derived is based on the location of the services being rendered. However, if a person working for a forein based business is a non-resident alien, spending 90-days or less in the U.S., earned less than $3,000 while in the U.S, then they fall under the commerical travler exception. As a result of the commercial traveler exception, they do not need to pay U.S. tax for services rendered.
• Disposition of Property. Real Estate: based on the prperty location. Personal Property: based on the seller’s location.

Expenses follow the same rules as income.

Allocation and Apportionment

The IRS is permitted to reallocate income and expenses among related persons so it knows where the income came from. See § 482. Most often, the IRS will utilize this power if the parties are engaging in transfer pricing (when corporations seek to transfer most of their revenue to be derived from a country with a lower tax rate).

Controlled Foreign Corporations

A CFC is a foreign corporation that is controlled by a U.S. entity (ownership of more than a majority interest if shareholders have more than 10% of an interest). CFCs could create Subpart F income which flows through to the U.S. shareholders.

Foreign Tax Credit

This is a U.S. tax credit when you pay taxes for income derived from foreign sources. The purpose of this credit is to reduce the potential of being double taxed (once in the U.S. and once in the foreign country). However, this credit is limited to the U.S. tax rate. So, the credit cannot exceed the lessor of: (1) actual foreign taxes paid or (2) a percentage calculated by taking the U.S. tax before the FTC and multiplying it by the percentage of the foreign-source divided by the worldwide taxable income (U.S. tax pre FTC * (Foreign-source/worldwide total taxable income)). Any excess can be carried back one year and carried forward for 10 years.

Taxing Nonresident Aliens and Foreign Corporations

Nonresident aliens and foreign corporations are only taxed on (1) income sourced from the United States, and (2) foreign-sourced income connected to a U.S. trade or business.

A nonresident aliens are individuals who are not citizens or a resident of the U.S. For tax purposes a resident alien are individuals who have a green card or have been in the U.S. for longer than 183 days (6 months) in the past year (or weighted more than 183 days over the past three years). However, students are not considered resident aliens for tax purposes.

Effectively connected trade or business in the United States include regular, substantial, and continuous business activity.

Tax Havens

Tax havens are countries that have (1) super low tax rates and (2) minimal financial disclosure requirements. These include Bermuda, Panama, Cayman Islands, Luxembourd, Ireland, and Lichtenstein.