Code Section 7701 (a)(30)
U.S citizens are U.S Persons and Citizens of foreign countries are U.S Persons who meet either of the following two tests:
Green Card test
Substantial presence test
Code Section 7701 (a)(4) and (a) (9)
A domestic corporation is any corporation created or organized under the laws of one of the 50 states or the District of Columbia.
A domestic partnership is any partnership created or organized under the laws of one of the 50 states or the District of Columbia.
Code Section 7701 (a)(30)(A) and (a)(31)(D)
Any Estate other than a foreign Estate.
Code Section 7701 (a)(30)(E)
Any trust if a U.S court is able to exercise primary supervision over the administration of the trust and one or more U.S persons have the authority to control all substantial decision of trust.
Code Section 901(a)
If a U.S person has a foreign income he can claim a credit for foreign income taxes paid. Under this credit system, foreign source income is taxed one time at higher of the U.S tax rate or the foreign rate. So if host country taxes at a lower rate, U.S will collect any residual U.S tax due on foreign earned income. If foreign tax rate is higher than the tax rate in the U.S no U.S tax is collected.
Example:
U.S Corp. is a domestic corporation and has $200 of U.S source taxable income and $100 of foreign source taxable income. Assume foreign tax rate is 50% and U.S tax rate is 30%.
Case 1 – Credit is limited to U.S tax
U.S Tax Foreign Tax
Taxable Income 300 Taxable Income 100
U.S Tax Rate .30 Foreign Tax Rate .50
Pre-Credit Tax 90 Foreign Tax Payable 50
Foreign Tax Credit 40
U.S Tax Payable 50
Case 2 – No Limitation
U.S Tax Foreign Tax
Taxable Income 300 Taxable Income 100
U.S Tax Rate .30 Foreign Tax Rate .50
Pre-Credit Tax 90 Foreign Tax Payable 50
Foreign Tax Credit 50
U.S Tax Payable 40
Deferral from U.S Taxation
Until the profits earned by foreign persons through a foreign corporation are repatriated to United States, there will be no tax consequences.
Code Section 1504
In contrast, U.S accounting principles require a “worldwide” consolidation, where by all majority owned subsidiaries, domestic and foreign alike, must be consolidated with the U.S parent corporation for financial reporting purposes.
The earnings of a regular corporation are not taxed to its shareholders until distributed as dividend.
The United States does not tax the foreign source income of foreign corporations. Therefore, as long as a foreign subsidiary derives only foreign-source income, those earnings will not enter the U.S tax base until they are distributed to U.S parent corporation as a dividend.
Example:
U.S Corp.., a domestic corporation, owns 100% of Forcorp, a foreign corporation. Forcorp is enjoying a 10 year tax holiday. In first year of its operations Forcorp earns 2 million dollars and repatriates 400,000 dollars of those earnings to U.S Corp through a dividend distribution. U.S will not tax income of Forcorp but 400,000 dollars of repatriated through dividends will be taxable. This dividend income will be included in U.S corporation’s gross income and will be taxed.
Code Section 911 – Foreign Earned Income Exclusion
If a U.S expatriate meets certain requirements he can exclude a limited amount of foreign earned income and housing cost amount. Region earned income exclusion for 2014 = $99,200
U.S Activities of Foreign Persons
Foreign persons include following:
Code Section 7701 (b)(1)(B)
Non resident alien individuals = Individuals who are neither citizens nor residents of the United States.
Code Section 7701 (a)(5)
Foreign Corporations = Corporations created or organized under the laws of a foreign country or U.S possession.
Foreign Partnerships = Partnerships created or organized under the laws of a foreign country or U.S possession.
Code Section 7701 (a)(31)(A)
Foreign Estate = Any estate that is not subject to U.S taxation on its foreign earned income which is not effectively connected with a U.S trade or business.
Code Section 7701 (a)(31)(B) and (a)(30)(E)
A trust is foreign if either no U.S court is able to exercise primary supervision over the administration of the trust or no U.S person has the authority to control all substantial decisions of the trust.
Code Section 871(b) and 882(a)
All foreign persons who have effectively connected income with the conduct of trade or business with in the United states are taxed on graduated rates.
Code Section 871(a) and 881(a)
All foreign persons who have U.S based investment-type income are subject to a flat tax rate of 30%.
Code Section 1441 and 1442
The U.S person who controls U.S source investment type income to a foreign person must withhold and deduct 30% U.S tax.
Code Section 871(h) and 881(c)
Income tax treaties will usually reduce the withholding tax rate on interest, dividend and royalty income from 30% to 15% or less.
Portfolio interest income is exempt from U.S tax.
Reg 1.441-2(b)(2)
Capital gains are exempt from U.S tax
Code Section 897(a)(1)
Capital gains from the sale of U.S real property are taxed in the same manner as income effectively connected with the conduct of a U.S trade or business.
Disclaimer:
This information is for educational purposes only. It does not constitute any legal advice or opinion. Please do not use any of its contents without seeking a professional advice.
References:
www.jct.gov/publications.html
http://www.law.cornell.edu
http://www.irs.gov/publications
U.S Taxation of International Transactions by Robert J. Misey, Michael S. Schadewald
Introduction to United states International Taxation by Paul R. McDaniel, Hugh j. Ault and James R. Repetti
International Taxation by Joseph Isenbergh
International Taxation in a nutshell by Richard L. Doernberg.
International Income Taxation, Code and Regulations by Robert J. Peroni – CCH
Mansoor Suhail (Mani)
Accountant
BSBA – EA – ICIA – RA
Tax for Canada and U.S.A
Web: www.theaccountingandtax.com and www.taxservicesguru.com
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