U.S. statutory withholding tax rules for FDAP income under chapter 3 (regular) and chapter 4 (FATCA for financial services industry) of the IRC
International tax fundamental concepts
Definition of “U.S. person”
The term “United States person” means
a citizen or resident of the United States;
a partnership created or organized in the United States or under the law of the United States or of any State, or the District of Columbia;
a corporation created or organized in the United States or under the law of the United States or of any State, or the District of Columbia;
any estate or trust other than a foreign estate or foreign trust. (See IRC Section 7701(a)(31) for the definition of a foreign estate and a foreign trust); or
any other person that is not a foreign person.
A foreign person includes a nonresident alien individual (NRA), foreign corporation, foreign partnership, foreign trust, a foreign estate, and any other person that is not a U.S. person. It also includes a foreign branch of a U.S. financial institution if the foreign branch is a qualified intermediary. Generally, the U.S. branch of a foreign corporation or partnership is treated as a foreign person. A nonresident alien is an individual who is not a U.S. citizen or a resident alien. A resident of a foreign country under the residence article of an income tax treaty is an NRA for purposes of U.S. withholding tax.
U.S. citizens, resident aliens, corporations, and fiduciaries are generally taxed on their export income in the same manner as on their domestic income from the United States.
U.S. businesses report income and deductions from export activities on the same tax returns used to report income from domestic sales. However, there are two significant differences:
1 Income may be considered earned by a U.S. business for purposes of U.S. taxation even though exchange or capital controls imposed by foreign governments restrict the ability of the business to use the proceeds of the export sale.
2 There are particular forms and schedules to be completed that reflect specific issues that arise only in international transactions.
Sessions Corporation, a financial services company, incorporated and headquartered in the United States, opens a trading office in Sao Paulo, Brazil. Sessions office in Sao Paulo attracts investment from several large Brazilian investors. Sessions collects commissions for these sales but is not allowed to return its commissions to the United States due to a currency control recently imposed by the Central Bank of Brazil. Sessions must nevertheless report the Brazilian commissions on its U.S. federal income tax return, absent an election to file a separate U.S. Form 1120 for blocked income.
Knowledge check
1 When a U.S. business has commission sales in country X but cannot remit the sales commissions to the United States due to currency control regulations in X, the U.S. business must recognize incomeWhen the sales commissions are remitted to the United States.On its U.S. federal income tax return.In an amount equal to 50% of the sales commissions.In an amount equal to 75% of the sales commissions.
Recognition of income
In general, businesses are considered to recognize income and are required to report the income for tax purposes when the business receives the income, accrues the income under generally accepted accounting principles, or has the right to obtain the income.
Time of payment
Generally, income is recognized when received or accrued. Recognition of income may take place earlier than actual receipt; however, when funds are deposited in a bank account in the name of the business or otherwise made freely available to the business. Similarly, recognition of income may take place later than actual receipt if the funds are subject to future contingencies.
A business may recognize income even though payment is made to another company. The determination of whether the recipient is acting solely for the business depends on whether the recipient is a real entity engaged in a real transaction.
Assume in example 1-1, that Sessions Corporation incurs a significant net operating loss in its Sao Paulo office and earns a substantial commission rendering services in the United States. Before collecting the commission, Sessions transfers the commission contract to its Brazilian subsidiary to shelter the commission income earned in the United States with the Brazilian loss. Upon examination of Sessions’ U.S. tax return, the IRS will include the U.S. commission in Sessions’ U.S. tax return.
U.S. businesses are on the cash method of accounting with respect to amounts owed to a related foreign person except where the related foreign person is a CFC, a passive foreign investment company or a foreign personal holding company, in which case the U.S. business can deduct accrued amounts as of the day on which a corresponding amount of income is recognized by the CFC, the passive foreign investment company or the foreign personal holding company.
Effective October 22, 2004, accrued but unpaid amounts due from a U.S. business to a related CFC or passive foreign investment company cannot be deducted by the U.S. business until a corresponding amount is included in the gross income of a U.S. person(s) who owns stock, directly or through a foreign entity, in the CFC or the passive foreign investment company.
Assume in example 1-1, that Sessions Corporation takes a working capital advance from its Sao Paulo office. The working capital advance to the U.S. office is documented in a promissory note and bears interest at a market rate. Sessions U.S. accrues a quarterly interest payment to its Sao Paulo office on December 31, the end of Sessions U.S. tax year and pays the amount accrued January 10 of the following tax year. Sessions U.S. cannot deduct the interest payment accrued but not paid December 31 until actually paid in the subsequent tax year.
Delivery of goods
In some situations, a U.S. business will recognize income when goods are delivered to a foreign person. If the purchaser makes advance deposits with the seller or the purchaser pays with an irrevocable letter of credit, delivery of the goods may trigger recognition of income to the U.S. business. However, if the U.S. business ships goods on consignment to a foreign dealer, the U.S. business will recognize income after the goods are sold by the dealer.
Introduction of International Tax Provisions enacted by the TCJA
Select general tax provisions of the TCJA