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Law Student Outlines Selected by Prof. George Mentz

 

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International Tax Outline Notes for Students

I. Jurisdiction to Tax
A. Based on Citizenship (tax on worldwide income)
1. US is in a minority of governments exerting a plenary taxing jurisdiction (based on citizenship) rather than territorial jurisdiction
a. This difference is exploited in tax planning
2. Cook v. Tait, 265 U.S. 47 (1924) 3/N1
a. US citizen moved to Mexico. His only income came from Mexico.
b. I: Whether the US had the power to tax that Mexican income.
c. H: Yes. Does not matter where the income was made or where the citizen lives. US has the jurisdiction to tax citizens on their world-wide income.
d. Rationale: The US government benefits its citizens and their property no matter where located.
(1) E.g., citizen to go to US consulate wherever and be safe inside those walls if necessary
3. Rexach v. U.S., 390 F.2d 631 (1968) 7
a. Naturalized citizen renounced his citizenship in 1958. In 1962, he reapplied for citizenship saying that his original rejection had been compelled. Application granted.
b. I: Whether IRS could tax Rexach for his income between 1958 and 1962.
c. H: Yes. The decision to grant him citizenship acted as if he had been a citizen all along. Benefits of citizenship exist whether the individual used them or not; they exist by the mere nature of government
d. If power to tax is from "status" of citizenship, then Rexach is right.
e. If instead it is from something else (e.g., substantive connection; substantial benefit) then Rexach is wrong.
B. Residence Jurisdiction over Aliens
1. Park v. Comm'r, 79 T.C. 252 (1982) 9
a. Park owned considerable property in the US, entertained frequently, and was listed in DC's green book (of socially prominent individuals). Also had a home in Korea.
b. I: Whether residence in another country eliminates ability to be a resident in the US
c. H: No. The duration and nature of his presence in the US, as evidenced by his deep and continuing involvement in business, etc., affairs, were sufficient to establish the kind of attachment and relationship to the US that constitutes residence within the § 871 Regs's requirements
d. Resident taxed on worldwide income (Non-Resident Alien (NRA) only taxed on US-source income)
e. Rebuttable presumption: NRA
f. Neither termination or abandonment of a residence in another country is considered a prerequisite to finding of US residence
g. Facts and Circumstances Test
2. Brittingham v. Comm'r, 66 T.C. 373 (1976) 21
a. TP moved to Mexico when 5 years old. Citizen at birth. Had an apartment in California, had a checking account, held a Mexican passport. She paid state tax, not federal, on basis of nonresidency
b. I: Whether she was an alien resident from 1960-1966.
c. H: Yes. She was able to reside continuously for 20 years in the US despite immigration restrictions.
d. Both physical presence plus the definite intent to make one's home at that place is necessary to establish a residence
(1) Mere physical presence in a country does not by itself establish residence
e. Presumption of non-residence is rebutted by showing that the alien's stay in the US has been of such an extended nature as to constitute him a resident
f. Facts and Circumstances Test
3. Treaty Tiebreakers (in order) (See US-Canada Treaty) N8
a. where he has a permanent home available to him (intends to return eventually)
b. where his personal and economic relations are closer
c. has a habitual abode (where he is most of the time)
d. where he is a citizen
e. shall be settled by mutual agreement
4. Savings Clause
a. saves the US from losing taxing jurisdiction over its own citizens as a result of the Treaty
b. not intended to soften the full worldwide tax of US citizens
c. Merely benefits the other country's citizens (eg., Canadians in US-Canada treaty)
d. Treaty provides foreign tax credit
(1) even if US repealed it in the tax code, it would still be effective
C. Analysis for Taxing Non-Citizens N3B
1. Are they citizens?
a. if yes, then subject to full US tax on worldwide income
b. if no, then go to #2
2. Are they US residents?
a. if yes, then full US tax, like a citizen
3. Are they non-resident aliens? (NRA)
a. taxed only on US-source income (§ 871)
b. if ordinary income, taxed at flat rate of 30%
c. capital gains are not taxed
(1) § 871(a)(2) provided that if in the US for more than 182 days, the would be taxed on US-source capital gains
(2) In 1984, § 7701(b) provided that if in the US for more than 182 days and passed the substantial presence test or green card test, then would be treated as a resident (subject to tax on worldwide income)
(a) THUS, gutted § 871(a)(2)
i) basis for Park, supra at p. 1
a) full taxation v. zero taxation because his income was entirely capital gains
(3) Current Rule: If in US for more than 182 days then a US resident and taxed on all worldwide income
(a) eliminated the Facts and Circumstances Test
(4) Green Card Test § 7701(b)(1)(i)
(a) if lawfully admitted to be a US resident
(b) if you have this status from the INS, then you are a "resident" alien for tax purposes
(c) taxed on worldwide income
(5) Substantial Presence Test § 7701(b)(1)(ii) N7
(a) at least 183 days during 3 years
(b) Regs make it clear that the date of entry and the date of departure are counted as time in the US for the purpose of calculating the 183 days
(c) 122 days in any given year is enough to give a client a problem N9B
i) § 7701(b)(3) over 30 days in current year start worrying about # of days for prior two years
d. Only remedy is to find an exclusion (§ 7701(b)(3)(C))
(1) "Closer Connection" N7
(a) if here less than 183 days in the current year;
i) IRS doesn't round days, but they use fractions
ii) cannot round up or down
(b) has a tax home in foreign country;
i) defined by § 301.7701(b)-2(c)
(c) AND has a closer connection to the foreign country 2(d)
i) it matters whether you are here on vacation or business
(2) exempt individual § 7701(b)(3)(D)(i)
(a) day by day analysis
(b) More information in § 7701(b)(5)(B)
i) Foreign-government related individual
ii) Noriega planning possibility from N10
a) his out: get Panamanian government to make his wife/kid/etc. a diplomat in US, then (5)(B)(iii) will apply
b) may or may not work, but it's a good faith effort
iii) looks to reason for his presence in US
(3) medical exclusion § 7701(b)(3)(D)(ii)
(a) wanted to leave, intended to leave, but was precluded from leaving because of medical condition arising while in US
(4) See § 7701(b) Regulations
(a) To Challenge Interpretive Regs, (e.g., § 7701(b)
i) will be invalid if it's beyond the scope of statute or unreasonable
(b) To Challenge Legislative Regs
i) Congress sets out list of things, gives Treas. right to promulgate Regs under them, and gives Treas. power for "any other that Treasury chooses to regulate"
(c) Either way:
i) file return taking position to the contrary to the Regs
a) must disclose that to avoid penalties
ii) IRS will audit
iii) Notice of deficiency — "90 day letter"
a) must be prepared to litigate
iv) File petition within 90 days in Tax Court
4. Rexach and Cook don't care
a. where you reside
b. if there's any property in the US
c. if the income is from the US
d. To avoid tax, must renounce citizenship
(1) cannot do so with a tax avoidance purpose
(2) § 877 prevents that
(a) will tax you for the next 10 years, but only on US-source income
(b) ONLY IF taxpayer proves non-tax avoidance purpose
D. Residence Jurisdiction Over Corporations N10B
1. § 7701(a)(4): Taxpayer chooses tax status based on place of incorp.
a. Available Tests in Code:
(1) Central management test
(2) Place of incorporation
(a) ** THIS IS THE LAW TODAY **

b. Poss. of tax planning:
(1) by choosing to incorp in tax haven country, and having that corp. own the foreign stock, you'd avoid US tax jurisdiction
c. CONSIDER: Subpart F (Controlled Foreign Corporations) Rules
(1) something close to the central management test
(2) taxes U.S. parent as if the CFC distributed a dividend (repatriating the funds)
(3) STRICT RULES
(4) See p. 26 for more info on CFCs
2. § 881 — taxes US-source income for foreign corps
3. § 882 — taxes effectively connected income

II. Taxation of Foreigners (INBOUND)
A. Income from Business Operations
1. Agency Relationship (in the form of Consignment)
a. Handfield v. Comm'r, 23 T.C. 633 (1955) 39
(1) Card manufacturer operating solely out of Canada. Spent 24 days in US, but had a consignment contract with American News Co. to sell cards in the US.
(2) I: Whether the tp, a nonresident Canadian was engaged in business in the US during the year in controversy
(3) H: Yes. The News Co. was an agent in the US for TP. THUS, through his agent, TP was engaged in a trade or business in the US; his US-source income is thus taxable (§ 871(b))
(4) Factors:
(a) cards were fully returnable
i) TP thus assumed the risk
ii) TP would allow credit on all unsold cards, regardless of condition
(b) TP pays shipping on returned cards
(c) TP set the end price to the retail customer
(d) TP gave exclusive rights to News Co. to distribute in US
(5) How to advise:
(a) who is assuming the risk
(b) restructure based on the court's factors
i) try to change terms of contract
a) so that US co. assumes the risk
b) US co. may not want to do this
ii) need an independent agent
iii) look to treaty for help
a) Article VII
b) only taxed in US if has a permanent establishment (treaty-based concept)
*) other than an independent agent if person can conclude contracts in TP's name; AND
*) habitually exercises this power
c) Code concept is "effectively connected"
(6) If TP had sold the cards to News Co., perhaps a different result
(a) would have needed to know:
i) where title passes (perhaps would not be US-source income if title passed in Canada)
2. US Subsidiary Deemed an Agent
a. Inverworld v. Comm'r, TC Memo (June 27, 1996) Supp 2A
(1) LTD was an investment company organized in the Caymans, which owned all of the stock of INC (a Texas Corp.). LTD was organized to provide US and foreign investment opportunities to InverMexico clients. INC invested the funds deposited by clients in US according to LTD's instructions.
(2) I: Whether INC was an agent of LTD thus making LTR engaged in the conduct of a trade or business through an agent (pursuant to § 864(b) or (c).
(3) H: Yes. INC is a dependent agent who had the authority to negotiate and conclude contracts in the name of LTD and regularly did so. LTD's trading in stocks was not entitled to the Higgins exception for trading on one's own account because LTD was a dealer in securities.
(4) Factors under Reg §1.864-7(a)(2) to determine whether TP has an office or other fixed place of business in US Supp 6
(a) fixed facilities
i) can be considered such even if TP does not use it continuously
(b) management activity
i) where top management decision-making happens vs. the day-to-day trade or business of the foreign corp
(c) agent activity
i) office of agent shall be disregarded unless agent has the authority to negotiate and conclude contracts in the name of NRA or foreign corp and regularly does so, OR agent has stock of merchandise of NRA or fc from which orders are filled regularly
ii) uses frequency tests
(d) employee activity
(e) office or other fixed place of business of related person
(5) * Facts and Circumstances Test * to determine whether engaged in the conduct of a trade or business
(6) SUBSTANCE OVER FORM
3. Partnerships
a. Cokes v. Comm'r, 91 T.C. 222 (1988) 43
(1) TP received working interest in Indiana oil field following the death of her husband (who owned the interest before). She had no involvement with any decisions in the oil field.
(2) I: Whether TP was subject to self-employment tax as a result of her earnings from the oil field
(3) H: Yes. Her formal arrangement by contract was a partnership agreement. THUS, even though she had nothing to do with the decisions, she was a partner and should be taxed accordingly
(4) Not an international tax case, but the principles translate to define how partnerships are held responsible
(a) Partnerships (Pships) are treated as pass-throughs
(b) THUS, if Pship would be engaged in trade or business in US, then tp would be liable for US tax as if tp was individually involved in a trade or business
(5) Determine:
(a) if TP is in US as a partner in a partnership, then . . .
(b) implications? TP will be deemed engaged in the conduct of a trade or business in US (§ 875)
i) if get § 875 treatment, then get US tax on all US source income effectively connected to that trade or business
(6) If partnership is engaged in the conduct of a trade or business at any time during the taxable year, then will be deemed engaged in the conduct of a trade or business for the entire year
(a) applies when TP liquidates corp 1/2-way through year and uses cap gains from liquidation to start partnership
4. Trading in Securities
a. Higgins v. Comm'r, 312 U.S. 212 (1941) 46
(1) TP was engaged in the business of managing his own investments as well as a real estate investment firm. Claimed deductions for expenses for ordinary and necessary business expenses. IRS wanted to apportion the expenses between personal and business. TP resided in Paris and did this business over phone, cable and mail.
(2) I: Whether TP's activities were deductible as business expenses
(3) H: Not entirely. His expenses should be apportioned between business and personal
(4) § 864 codifies Higgins
(a) gives authority for "not engaging in the conduct of a trade or business in US" at all
(b) dividends from these investments will not be taxable in US at all
(c) even if have a broker
(d) still not treated as engaged in trade or business
5. Check-the-Box Regs
a. any non-corporation can elect to be taxed as a corporation
b. must be consistent about their choices
c. codified Dec. 17, 1996, effective Jan. 1, 1997
B. Transfer Pricing: Tax Avoidance by Foreign-Based Entities N/15 & N/18
1. Related-Party Sale

TP $1 cost
$98 profit taxed in Canada

HC
Canadian Sub $99 sale
assumes risk of cards
Canada
US Sells to distributor at $99
US Distribut'n Deals cards for $101
THUS: $2 gain taxable in US

a. Even if distributor is a pure conduit:
(1) Canadian sub (HC) will be engaged in a trade or business in US
(2) IRS won't get much because the income attributable will be $2
(3) NOT $100 representing the entire profit
b. Can do the same thing economically if incorporate the sub in the US
c. This assumes that Transfer Pricing works (which it doesn't)
d. Defin: the price that the foreign manufacturer charges to subs = "transfer price"
2. Inbound transactions: § 482 prevents this scheme N16
a. deceptively simple section
b. gives Treas. the authority to come in and look at the transaction
c. would reallocate some of the $98 income in Canada and allocate it to the US sub
d. powerful weapon, but requires intense factual analysis
e. Treas. proposed Regs. requiring companies to keep records in English
(1) hard to determine which records should be translated
(2) hue & cry to protest this
3. Outbound transactions: CFC Regulations to prevent abuses
a. US co. wants to sell products in France
b. Title passage is irrelevant because it's a US co (US already has jurisdiction to tax)
c. Transfer pricing between US parent and Cayman sub for $2 and then sale to France would keep the profit in Caymans (tax haven)
d. CFC Rules allocate the profit in Cayman to US parent if Cayman co. is merely a pass-through
(1) See page 26 for more info on CFCs
4. Controversial Ways to Make § 482 Work:
a. APA (advanced pricing agreement procedure)
(1) company can come in to IRS for a ruling on intercompany prices
(2) Barkleys Bank -- first to receive APA
(3) biggest incentive: will work both with the domestic sub and the foreign parent
(4) Problem: Foreign country has already subjected the $$ to foreign tax
(a) THUS, already double taxed
(b) § 482 adjustment makes settlement harder
(c) BUT, if both countries agree to the APA, then you have no problem
b. Allocation of Judicial Resources
(1) § 482 threatening to clog the Tax Court
(2) worse than tax-shelter cases in the mid-1980s.
(3) So, Tax Court offers an alternative: arbitration
(a) baseball-type arbitration
(b) each party chooses a number (arbitrator will pick either one of the numbers -- cannot pick somewhere in the middle)
(c) THUS, makes each party really try to hit the exact number
(4) process designed to force the parties to work it out
(5) resolution is unpublished
5. Determining Arms Length Prices
a. Super Royalty Provision of § 482 N21
(1) Deals with intangible property (intellectual property)
(2) companies can come up with standard info for charging for royalties
(a) Problems: there are at least some patents that are more valuable
i) eg. drug to cure AIDS v. another analgesic
b. Areas targeted by § 482 54-55
(1) rebates
(2) advertising expenses
(3) warranty costs
(4) freight costs
(5) interest
(6) insurance
(7) accelerated ded'ns
c. Ways to Determine Arms Length Price N20B
(1) Comparable, Uncontrolled Price Method
(a) What a CUP would have paid for this item
(b) Problem: Who is comparable to whom?
(c) Economists figure this out (price theory)
(d) There might be no comparable party
i) eg. patent (legal monopoly)
(2) Cost Plus Method
(a) retailer sets the ultimate sales price and normal industry market is X (eg. 10%)
(b) THUS, find out the "normal price" between manufacturer and distributor
(3) Profit Split Method
(a) where manufacturer and distributor agree to split profits 50-50
(b) economists must figure this out
(4) Problems:
(a) how to measure this income
i) offset cost of developing? (R/D)
(b) looking retrospectively (after the income has been made)
(c) product-specific
d. Similar to § 367 (basis to foreign corps)
e. See example of Handfield argument from the outbound side N22
(1) further examples of problems with the arms length test
(2) Blocked Income Doctrine: foreign law provides a limit to the market & IRS can't force foreign companies to break the law
C. Currency Exchange Problem
1. Notes p. 19B
2. Question is When you translate into the new currency
D. Tax Treaties N23
1. See page 2 for a list of Treaty Tiebreakers N8
2. Withholding
a. §§ 1441, 1442 make §§ 871, 881 a problem for US payors
(1) withholding is a method of collection
(2) no need to file a return

b. Aiken Indus. v. Comm'r, 56 T.C. 925 (1971) 64/N23A
(1) See diagram on 65. MPI borrowed $2.25 million from ECl; agreed to pay interest, but paid it to Industrias (Honduras) instead of ECL. ECL paid Industrias $2.25 million in exchange for notes of the same value.
(2) I: Whether treaty between US and Honduras exempted the interest paid by MPI to Industrias from tax, thus eliminating the need to withhold at source (MPI)
(3) H: No. In sum, Industrias got back exactly what it paid out and the transaction had no business purpose. Thus, tax avoidance reason here required taxation.
(4) This was interest income that § 881 taxes to ECL as US-source income to non-resident
(a) no mechanism to collect the tax unless use § 1441(a).
(5) US-Honduras treaty does not immunize interest payments from US withholding b/c Ct focuses on words of Art. IX (see fn. 6 on p. 66) (referring back to interpretation of US law)
(a) gives broad authority to interpret meaning of words "received by" consistent with US law
(b) because Treaty does not apply, § 881 allows IRS to withhold
(6) Treaty Shopping
(a) anti-treaty shopping provisions in US treaties
(b) eg., US-Canada treaty
i) Article 29(A) (p. A-34 of Text) N.23D
(c) Lessons
i) advent of anti-treaty shopping provisions did not make Aiken chain of events not possible, impossible to win a tax argument with IRS
ii) Limitation provision like Art 29A would probably have killed Aiken (limited to certain types of residents)
iii) possible to plan around limitations provisions
3. Capital Gains Exempted from Treaty
a. Botai Corp. v. Comm'r, TC Memo 1990-475 (1990) 68
(1) Botai, a Netherlands Antilles corp, bought land with a Florida corp with intent to develop it. Changed mind. Sold land for a $4.9 million note. Botai then tried to establish residency in the UK. Sold note for $5 million.
(2) I: Whether the gain from the sale was capital or ordinary (b/c US-UK treaty exempted only ordinary gain)
(3) H: Capital, based on the character of the underlying asset. THUS, US-UK treaty does not apply to exempt the income. (§ 897 acts to override the treaty because the treaty did not contain a cap gains article).
(4) Imp: Botai was a shell corp and had no purpose. Same in UK: managed and controlled outside of UK (no assets or employees in UK)
(5) P'ship consequences:
(a) tax consequences for $2.8 million cash
(b) the $4.9 m. is installment loan
i) no tax consequences on receipt of a note (§ 453 — not in our Supp)
a) deals with purchased money mortgage
b) sale of property on installment basis
c) complicated section because there's a high potential for abuse
ii) Code allows you to elect to be taxed later as an installment sales contract
a) if do nothing, will be deemed to get installment basis
(6) Sample Installment Basis
(a) Amt realized = $5 million (note)
(b) Basis = $2.5 million
(c) Gain is thus $2.5 million (equiv. to 50% of amt realized)
(d) THUS, each time get a payment, will be taxed on 1/2 of payment (represents amount of gain)
(e) Hence, disposition of the NOTE becomes the realization event
(7) Why do we need the treaty to have the cap gains not taxed?
(a) Botai in US only within a partnership (Pship)
i) § 875 in t/b if Pship is so engaged
ii) See Cokes, above
(b) Looks like a Higgins type of investor for his own account (§ 864)
i) THUS, not t/b
(c) Capital asset (land)
i) unlikely to rise to t/b in US
ii) THUS, partners are not engaged in t/b in US
(d) § 881 not connected with US Business
i) no tax on capital gains
ii) § 871 (183 day rule for NRA, but not applicable to corp because corp does not physically exist anywhere
(e) BUT: § 897 overrides lack of tax consequences on capital investments
i) G/R: gain on disposition of real property in US recognized as if Tp were engaged in the conduct of a trade or business
4. Agent of "Independent Status"
a. Taisei Fire & Marine Co. v. Comm'r, 104 T.C. 535 (1995) 71
(1) Japanese insurance companies (Petitioners) used Fortress to set up their reinsurance contracts. Petitioners attended monthly industry meetings where each is present, but they have never met to discuss Fortress.
(2) I: Whether petitioners had a US permanent establishment by virtue of the activities of a US agent (Fortress) in accepting reinsurance on behalf of each petitioner.
(3) H: No. Fortress was legally and economically independent of each petitioner, thus meeting the definition of "agent of independent status" under the US-Japan Treaty
(4) Commercial profits of a Japanese resident are exempt from US tax, unless such profits are attributable to a US permanent establishment
(5) Analogy of employee v. independent contractor is of limited use
(6) Sum of $27 million over 3 years was not what you would pay to a subservient company
(7) IRS's best argument: these 12 met together, thus they're acting as one group
(a) contra: this is an example of Merryl Lynch serving multiple clients
5. Alternative Minimum Tax
a. Lindsey v. Comm'r, 98 T.C. 672 (1992) 79
(1) TP was a US resident who had retired to Switzerland. He paid $24K in taxes to Switzerland. Filed 1040, claiming tax liab of $14K, which he offset completely using his foreign tax credit. IRS claimed foul; said that he owed the alternative minimum tax (§ 55) of $9156 of which he could only avoid 90% (thus, he should owe $900). TP argued that this was double taxation.
(2) I: Whether the Treaty, proscribing double taxation, supersedes the IR Code requiring that 10% of alt. min. tax must be paid
(3) H: No. The final (most recent) act by the sovereign (US) will supersede. Here, the IR Code wins.
(4) G/R: When a Treaty & an Act of Congress conflict, "the last expression of the sovereign must control."
(5) Treaties do not enjoy status superior to acts of Congress.
6. Kinds of Things Treaties Generally Provide:
a. include taxes covered
(1) typically only cover federal income tax
(2) not SSA tax, state, local, estate, gift, etc.
b. residence tiebreaker provisions
c. definition of permanent establishments
d. look for the real property article (Article XI in US-Canada Treaty)
(1) FIRPTA triggered (see chart for more info on FIRPTA § 897)
e. interest and dividends
(1) if no treaty applies and Canadian citizen receives interest or dividend from US sources, § 871(a)/§ 881 --> 30% flat rate
(2) FDAP income (see table: § 871 ordinary income)
E. Branch Tax N28
A. U.S. Corporation
B. U.S. Branch
J
(Spain) J
(Spain)
after-tax dividend $1610

S
(U.S.) Branch
in U.S.
$1000 = basis in property
$3000 = fmv
THUS: $2K gain on A/R
* tax 35% (§11) = $700
* left = 2300 as dividend
* Can Remit $2300 straight to J
* BUT b/c J is not a US parent, there's an additional tax
* §881 taxes the dividend by 30%
(an add'l $690)
effect: $1390 is total tax liab. $1000 = basis in property
$3000 = fmv

Decision re: shielding assets does not affect choice between Branch or Sub
Could incorp outside of US (adding another tier) to shield assets from tort claims
Effect: still have the § 11 income (via § 882) because branch os engaged in t/b in US, with effectively connected income (ECI)
** BUT: avoid second tax because there's no need to remit a dividend b/c the profits are already owned by the parent

1. § 884 intended to halt this choice of entity being driven on tax reasons
2. Key: Dividend Equivalent Amount
a. Situation where there's no need to remit a dividend to a foreign parent (because foreign parent already owns the branch's funds)
b. Concept: look at the investments in the US over the course of the year
(1) at the end of the year, we see that you've had $2000 more in US assets (but don't look like you've paid a dividend to a foreign parent)
(2) § 884(a) imposes 2 taxes (§882 corp tax, and an additional 30% on the dividend equivalent amount)
3. Calculation (§ 884(b))
a. Allows for cases where companies would not have paid a dividend (where all the E&P wouldn't go to the foreign corp)
b. In this case, effectively connected E&P of $2000 is reduced to zero because of § 884(b)
c. Allows for adjustment of E&P to account for reinvestment in the US versus abandonment of US investment in favor of repatriating the assets to foreign corp
d. Examples:
(1) Foreign corp has $100 effectively connected E&P (ECEP), but purchases an additional $100 in US assets (increasing US net equity)
(a) the $100 ECEP is reduced by the $100 new assets to make a $0 (zero) dividend equivalent amount
(b) Takes into account fact that this branch did not remotely repatriate those earnings to the foreign corp (instead reinvested them in the US)
(2) Foreign corp has $1000 of net equity in 1986. Has $100 new assets in 1987 (to counteract $100 new ECEP), and zero ECEP in 1988. But it decreases its US net equity in 1988 by $40.
(a) THUS, has a dividend equivalent amount of $40 in 1988 (subject only to the limitation of $100 accumulated E&P) representing the amount of assets that have been effectively transferred to the foreign parent
4. Limitation § 884(b)(2)(B)
a. can only increase dividend equivalent amount by the amount of accumulated ECEP previous year
b. if zero accumulated ECEP in previous year, then make no adjustment (dividend equivalent amount would remain at the $2000).
c. Example:
(1) Jan 1 net equity: $3000; Dec 31 $500
(2) ECEP current year is $2000
(3) Difference between Jan 1 & Dec 31 amounts is $2500, want to add the $2500 to dividend equivalent amount so that it all gets taxed twice (as all corp. tax should be)
(a) looks like branch repatriated funds to foreign corp
(4) BUT, if accumulated ECEP from previous year was only $1001, then could only add $1001.
(5) Dividend equivalent amount would be $3001 ($2000 ECEP plus $1001 limitation).
(6) If we taxed on the excess, we'd be taxing on capital contributions
5. Big Difference between Corp & Branch
a. corp has to actually declare a dividend
(1) could defer § 882 tax indefinitely if you don't declare a dividend
(2) could get the E&P to parent by a loan
(a) interest would be income, but it's a fraction of what you repatriated
b. branch merely has to have ECEP and have a reduction in US net equity
(1) if land devalues, then US net equity will decrease, but it will have nothing to do with repatriating assets
(a) Still will add that amount to ECEP to get dividend equivalent amount
6. How US taxes corporations
a. Earnings of corp taxed twice
(1) § 11 -- tax earnings and profits
(2) § 61 income to individual shareholder (or § 881/882 if foreign shareholder) upon a distribution of a dividend
b. Must separate out:
(1) distributions of corporate income to shareholder; and
(2) returns of capital
(a) concept of basis (want to tax income only once)
c. THUS, focus on E&P
(1) any distribution to shareholders is deemed to be out of E&P if corp HAS E&P
(a) Anti-abuse policy
(b) regardless of how the corp couches it
(2) defines dividend as distribution out of E&P
(3) This explains why amount of § 884 tax has to be limited by amount that would be the branch's E&P
7. How we treat the payment of a dividend to the Corp
a. corp gets no ded'n for paying a dividend to a sh
b. if investor loaned money to corp and charged interest, same effect as a dividend to the shareholder
(1) at corp level, payment of interest is deductible
(2) complete end run around the corp tax
(3) THUS-- earning stripping provisions which seek to stop this practice
c. Earning Stripping Measures (§ 163(j))
(1) Allows IRS to deny deduction where the interest payment really looks like a dividend
(a) THUS, would deny the deduction
(b) disqualified interest includes that paid to a related person
(c) § 267(b) attributes ownership for a related person
(2) Uses a debt-equity ratio — § 163(j)(2)
(3) See p. 33 of notes for hypothetical construction here
(4) § 163(j)(7) Regs: broad grant of Legislative Power (thus, legislative regs)
(5) § 163(j)(7)(c) requires coordination with § 884
8. Comparison of § 163 and § 884 N34
a. § 884(e) anti-treaty shopping provision
(1) See Aiken Industries at p. 10
(2) requires residency in treaty country
b. § 884(f) treats interest paid by a branch as if it were interest paid by domestic corp
(1) triggers withholding
c. § 884(g) extraordinarily broad reg-writing authority
F. Expatriation N35
1. Furstenburg v. Comm'r, Nov. 26, 1984 Supp
a. TP, wealthy woman, expatriated in favor of adopting her new husband's nationality (Austrian). She lived in Paris throughout. After her expatriation, she sold some US securities.
b. I: Whether § 877 should apply to petitioner because of any tax avoidance motive
c. H: No. Court found no tax avoidance motive because she was subjected to more tax than she would have been had she planned better
2. § 877 (as amended) Supp
a. if litigate and lose, § 877 provides that the applicable rate is the higher of § 871 (30%) and § 877(b) (alt. min. tax)
b. See chart for analysis of section
c. (c) provides four categories of individuals who will not be presumed with a tax avoidance motive

III. Source Rules
A. Combination of Source Rules and Expatriation
1. Hypotheticals
US Source
Foreign Source
$100,000 capital gains $100,000 capital gains
$50,00 ordinary income $50,000 ordinary income

a. if a US citizen, all of the income is taxable in the US
b. if NRA,
(1) no capital gains are taxable (unless here longer than 182 days, in which case would be taxed as resident on all worldwide income)
(2) no tax on foreign source income
(3) tax on US-source ordinary income: 30% flat rate
c. if former US citizen expatriated for tax avoidance reason
(1) taxable as alternative minimum tax (§ 877(b))
(2) § 877(a)(2) presumes tax avoidance purpose (non-rebuttable)
(3) certain individuals only:
(a) high tax liability (not taxable income)
(b) see p. 35B for more information
B. Identifying the Proper Source Rule
1. First, determine what this income is,
2. THEN, look up the source rule for that category of income
3. Services (§ 861(a)(3))
a. Comm'r v. Peidras Negras Broadcasting Co., 127 F. 2d 260 (5th Cir. 1942) 93
(1) TP had radio station in Mexico. Ran it from Mexico, creating all income-producing contracts in Mexico. Had a mailing address in El Paso, TX, where it read mail and processed funds.
(2) I: Whether TP derived any income from US sources, thus subjecting it to US tax
(3) H: No. Services are sourced where the services are being performed. Here, it's in Mexico. THUS, cannot be taxed in the US on that income.
(4) Dividing line between § 881 and § 882 is whether a business is engaged in the conduct of a trade or business within the US
(a) if yes, § 882: taxed only on income effectively connected to US (and US source income regardless of effectively connected) (can include foreign source if effectively connected)
(b) if no, § 881: only on US source
(5) § 863(e) seems to apply to Peidras Negras because it's transmission of communications from a foreign country to US
(a) BUT, legislative history suggests that this was meant to include telephone transmissions only
(6) Dissent:
(a) facts taken together show that TP had substantial contacts with US and even benefited from daily use of the US mails
(b) THUS, 2 grounds on which should be taxed as US source
i) doing business in US
ii) income from US sources
4. Foreign Inventor Licenses Patent in US (Hypo on N37)
a. "Sold" Property
(1) G/R: sourced under residence of seller (§ 865(a))
(2) Sale of inventory property is different
(a) location of sale matters (§ 865(b))
(b) location of sale determined by UCC or other rules (typically, it's where title passes)
(3) THUS, sellers have unfettered discretion to source the income from the sale of inventory property
b. Payments Contingent on Productivity or Use
(1) § 865(d)(1)(B): treated as if they are royalties (based on place of use of the property)
(2) BUT, if structured by a flat fee (not contingent on use), then NRA would not be taxed at all because this would be foreign source
c. Provision of Research Services
(1) Rule: where the services are performed
5. Mixed Categories of Income (Services v. Sales)
a. Comm'r v. Hawaiian Philippine Co., 100 F.2d 988 (9th Cir. 1939) 96
(1) TP transported sugar to US from Philippines. IRS assessed a deficiency in amount of $66K.
(2) I: Whether this income was from sources without the US (foreign source income)
(3) H: Yes. The court agreed that the sugar received by the TP was compensation for milling services and constituted income to it to the extent of the fair market value at the time and place of its receipt. To this extent, respondent's income was foreign source. Upon the sale of the sugar to the US, the respondent made no profit (derived no gain), therefore it received no US source income
(4) Seems to be a performance of services analysis (thus sourced at location of services) even though the products were sold in US (but for no profit)
(5) Would have been different if sold for some profit in US
6. Royalties
a. Sanchez v. Comm'r, 162 F.2d 58 (2d Cir. 1947) 98
(1) TP (NRA) patented in US and foreign country a process to refine sugar. He granted Becco (NY Corp) a world-wide license, for which Becco agreed to pay royalties of $25K per year.
(2) I: Whether the royalties TP rec'd as his "share" of the proceeds from the sale of the product were includable as US source, even though they were ultimately received abroad
(3) H: Yes. When he received payments from the seller, he did so through the US corp, this changing the source of the funds
(4) If US co gets money from using foreign patent, it's foreign source
(5) Income coming to TP through a US corp changes the source
(a) because separate taxpaying entities
(b) if had been with a limited partnership, then Pship would have been a mere conduit
i) result would have been different
ii) foreign source would have been retained
C. Allocation of Gross Income by Formula (Mixed Source Income)
1. Favell v. U.S., 16 Cl. Ct. 700 (1989) 126
a. TPs were professional hockey players, all NRAs. Sought to allocate their contract income to include only a portion as US-source
b. I: Whether TPs should be allowed to exclude that portion of their salaries earned for alleged contractual services performed outside the US during the off-season (e.g., training in the off-season, endorsements during the off-season)
c. H: No. The off-season conditioning activities are not compensated by the contract. Maintaining an ability to perform properly a professional obligation is not generally compensated separately, but is assumed to be a condition for retaining employment
d. Formula:

# of days in US X Total Contract Price = Amount includable as US income
total # of days compensated

e. Conditioning is a mixed motive expense
(1) IRS: "Why the employer doesn't provide for it, when it clearly has a benefit from the activity, then it's personal"
(a) THUS, it's personal even during the on-season if it's not provided by employer
(2) During the off-season, employer not providing it, so you have to get a deduction for your off-season business expenses
f. Planning:
(1) if you rewrite the contract by saying that you must arrive to day 1 of training camp able to do X laps, then it seems to get closer to a term of the contract
(2) Don't want to be arguing against your own contract terms, so write it with these things in mind

** Source rules for the next three cases are relevant for foreign tax credit limitation! **

2. Phillips Petroleum Co. v. Comm'r #1, 97 T.C. 30 (1991) 103
a. Phillips provided liquified natural gas (LNG) from US natural resources. Sold them to Tokyo companies. Contract required sale to occur in Japan. IRS assessed a deficiency when TP claimed mixed source.
b. I: Whether Reg. § 1.863-1(b) (which attributed natural resources obtained from the US as solely US source) was valid
c. H: No. Although a legislative reg., it contradicted the clear language of § 863 of the Code. However, TP is required to use example 1 if all conditions are present. (Thus, all natural resources did not have to be sourced domestically). This is now a mixed source issue.
d. Dissent:
(1) This Reg was passed almost concurrently with the code section, and has been valid for 69 years. The Court cannot invalidate it at this late date
e. Key to using Example 1 is having a distributor or being able to figure out what the IFP is
(1) IFP seems to trigger similar questions as "transfer pricing" issues (§ 482)
(a) how to allocate when there's only one sale and one price
(b) TPS would rather have a concrete formula (clarity, less time/fact specific)
(c) Default rule seems to be IFP (From Reg)
i) provided that you have both an IFP and a selling or distributing branch (see Phillips #2)
ii) if can't figure out what would have happened, then go to the 50-50 apportionment
(2) See Transfer Pricing, supra at page 8
f. Once Court determines that TP was entitled to treat the income as mixed source, then
(1) go to Reg to determine how to allocate
g. Source matters here (even tho it's a US company) for foreign tax credit reasons
h. Theory:
(1) Natural resources are not moveable, while a boot factory (LLBean) can operate anywhere
(2) THUS, place of extraction should have primary taxing jurisdiction over the income of the natural resources
i. ** Court based opinion on Corpus Juris Secundum (probably a worse source than Webster's Dictionary) **
(1) THUS, result driven
3. Intel Corp. v. Comm'r, 100 T.C. 616 (1993) 113
a. Intel sought to use Example 2 (in Reg. § 1.863-1(b)) to allocate its income between foreign and domestic sources. Income was from third-party export sales.
b. I: Whether the IRS may require the allocation method of Example 1 be used to determine the source of TP's income earned on foreign sales of its goods manufactured domestically, even though TP did not maintain a selling or distributing branch or department located outside the US
c. H: No. The plain language of Example 1 requires both that an IFP (independent factory price) exist with respect to the goods sold and that the sale be made through a selling or distributing branch or department for a cross-border sale to be sourced by Example 1.
d. Export Source Issue
4. Phillips Petroleum Co. v. Comm'r #2, 101 T.C. 78 (1993) 117
a. Same as pvs.
b. I: What is the proper allocation of the income generated by the sales of product to foreign buyers (Tokyo Electric and Tokyo Gas)
c. H: Example 1 does not apply b/c neither TE or TG were distributors for TP. As for Example 2, the court's holdings are as follows:
(1) location of a sale of property, whether within US or a foreign country, is determined by the passage of title rule;
(2) only property owned by TP is includable in the property apportioned fraction (THUS, no leased property);
(3) does not include property not in the US or the target country (here, Japan);
(4) accounts receivable were located in Japan;
(5) intangible such as shoken or good will is property for purposes of the property apportionment fraction;
(6) only tax appraisals count
D. Source Rules Under Tax Treaties
1. Boulez v. Comm'r, 83 T.C. 584 (1984) 135
a. TP was a French conductor residing in Germany. He entered into a contract with CBS Records to make records of his performances. Paid German taxes on the income.
b. I: Whether the payments received by petitioner were royalties (sourced upon his residence) under US-German treaty such that the amount would be exempt from US tax
c. H: No. Nothing in the employment contract indicates that the parties intended to enter into a contract for royalties. Further, TP never had a property interest in the recordings to transfer to anyone. THUS, this was a contract for personal services, sourced at the place where the services were performed (subject, therefore, to US taxation)
d. TP was required to do the conducting in the US
(1) closed theater (not open to the public)
(2) solely for the purposes of recording
(3) perhaps more like an employee than a royalty-holder
e. If public performance, his income doesn't depend exclusively on royalties (would be compensated for services in US separately)
(1) Then, more like a property right
E. Implications of Electronic Commerce
1. where are the services performed when they're over the Internet?
2. "server" is the intermediary
3. THUS, not as direct as telephone communications
4. Problem about how to source it
a. also have problems with state "use" taxes
b. See p. 38 of notes for more info on use taxes

IV. Foreign Tax Credit
A. Basics (§ 901)
1. Purpose: allowing you to get credit for amount equal to, but not in excess of, U.S. tax due
2. Elective by TP
a. may change the election at any time by filing an amended return
3. Formula based on: all foreign source income (what US tax is due) and all of your foreign tax paid
a. can carry forward to carry back foreign tax credits to other tax years
4. Whether you get a foreign tax credit depends on whether it's "foreign source" according to US law
a. if sales income in foreign country and US source rule says "foreign source" then eligible for foreign tax credit
b. BUT, if foreign country taxes TP, and US rule says "US source", then TP is out of luck for the foreign tax credit
(1) can deduct the foreign tax paid under § 164
(2) MUST CHOOSE between deduction and credit (can't have both) Reg. § 1.901-1(a)(4)(b)
B. Identifying Creditable Taxes
1. General Rule: Must be income tax, war profits tax, or excess profits tax.
a. justification: purpose is only to limit double income tax consequences
b. Foreign tax must reach net gain (See Reg. § 1-901-2(b)(1), (2), (3), (4)): (thus, it must have the following):
(1) realization requirement
(2) gross receipts (not a flat fee)
(3) net income (netting out costs & expenses through deductions)
c. Mere definition of base is not enough
(1) Must also look at the rate
d. If it's a fee for service rather than a tax:
(1) no creditable under § 901
(2) not deductible under § 164 as foreign taxes paid
(3) but if it's a company-taxpayer, then it could be deductible under § 162 (ordinary & necessary business expense)
2. Bank of America v. U.S., 459 F.2d 513 (Ct. Cl. 1972) 153
a. Domestic bank had branches in Thailand, Argentina, and Philippines. Paid different taxes in each jurisdiction. Sought refund under foreign tax credit
b. I: Whether these taxes were appropriate "income taxes" under domestic law to qualify for the tax credit
c. H: No. An income tax is a direct tax on gains or profits (not on costs & expenses) and that gain is a necessary ingredient of income. Income, including gross income, must be distinguished from gross receipts which can cover returns of capital
d. Key: whether the foreign company is trying to reach some net gain
e. Could also get to the same result if you can show that the tax looks like a tax on profits only
(1) designed to raise the same amount of revenue
3. Rev. Ruling 91-45 (Mexican Assets Tax) 157/ N45B
a. Suggests that there's no problem with the Mexican Income Tax
b. I: Whether the interaction of the Mexican income tax and the Mexican assets tax reduces the amount of Mexican income tax paid or accrued for purposes of § 901
c. H: No. (See Reg. § 1.901-2(e)(4) -- multiple levy analysis) The income tax amount (levy 2) is fixed, and thus any perceived reduction by the assets tax does not reduce the total tax liability established by the income tax.
(1) See N46
(2) Perhaps assets tax is just a minimum tax to ensure that the State gets at least the $25.
(3) If reverse then, so that assets tax is fixed, the it reduces the income tax liability, thus reducing your credit
d. The assets tax is imposed in addition to the income tax, and cannot qualify as an in lieu of tax for purposes of § 903
C. Commentary on In-Lieu Taxes
1. § 903
2. Suggests the repeal of this section as a massive loophole
D. Limitations on Credit
1. Policy against giving credit for exact amount paid in foreign taxes (even if above US tax):
a. all business would leave the US
b. Mexico (e.g.) would be tempted to raise taxes on only Americans (because the US would pay the Americans the balance)
c. US would actually be subsidizing Mexico
d. THUS, credit limited to what you actually paid in foreign taxes
2. § 904 N46
a. Total amount of credit cannot exceed current US tax bill
b. Formula:

X (limitation on credit) = Foreign Source Income
total US fed. inc. tax liability Total Worldwide Income

(1) THUS, credit is a reflection of a direct link between the percentage of foreign source income
(2) See example of computation on N46B
(3) Ends up being that credit is limited to amount of US tax that would be due on the amount of foreign source income (rather than entire US tax bill)
c. Another version of formula:

US tax x Foreign Source Taxable Income
Total Worldwide Taxable Income

(1) fraction there is the "Limitation Fraction"
d. Basket Limitations
(1) added in 1986
(2) in general: although foreign tax credit allows you to lump foreign source income from all countries, you must separate types of income among those countries
(a) THUS, § 904(d) ends cross-crediting re: passive income
(3) attaches to taxable income (after deductions)
e. Foreign source deductions
(1) NEVER want to allocate deductions to foreign source income (although you sometimes have to)
(a) because would reduce your numerator (thus reducing your limitation amounts and reducing your foreign tax credit
(2) Instead, want to reduce your US source taxable income
(3) Foreign source taxable income determined exclusively by way of US Code
(a) doesn't matter what deductions the foreign country would have given you
f. Hypo
(1) if US corp has a corporate subsidiary in France:
(a) assume Fr. taxes corps same as US
(b) flat 30% withholding tax on dividend payments to foreign parents
(c) THUS, US corp bears a burden of the two levels of French corp tax because they are the same economic unit
i) BUT, because it did not directly pay the first corp tax, it is not eligible for § 901 credit
E. Deemed Paid Credit (§ 902)
1. If US parent owns 10% of foreign corp, US will let you pass-through the foreign tax paid
2. THUS, US corp will have excess credits, and will get to use foreign tax credit for the full amount of foreign tax you economically bore
3. § 902 also provides this credit for tiers of corporate organizations (eg., several subsidiaries)
a. LIMIT: only allows three tiers, like this:
US Parent
Foreign Sub (1)

Foreign Sub (2)

4. Only get to § 902 if the foreign sub pays a dividend
a. OR, if by way of CFC rules, foreign sub is deemed to have paid a dividend (see below at p. 26)
(1) not a huge issue because wouldn't put passive income in a high tax jurisdiction
5. can get around this issue if you have a partnership (use pass-through status)
a. or, set up a branch
(1) problems:
(a) CFC issues (although they would exist with corp subs, too)
(b) business issues: get no benefit of limited liability (exposing entire corporate structure to liab in foreign country
b. Check-the-Box Regs apply here
(1) check the box to indicate your choice of entity
(a) IRS allows it provided that you're consistent
(2) corporations can thus decide to be treated as a partnership in foreign country
(a) gives limited liab in foreign country
(b) for US purposes, are pass-throughs
i) § 902 irrelevant

V. Controlled Foreign Corporations (§ 951 et. seq.)
A. Addresses the following problem
1. earnings of foreign subs of US corporations are not taxed until those earnings are repatriated to the U.S. parent (via dividend)
a. want to give country of origin primary taxing jurisdiction because doing business in that country
2. indefinite tax deferral
3. perfectly fine until you add "passive income"
a. deferral now no longer makes sense
b. no longer makes sense to give foreign country primary taxing jurisd.
c. becomes tax avoidance, pure & simple
d. no longer makes sense
4. Solution through Subpart F:
a. If foreign sub is a CFC (look to definitions) with Subpart F income (look to definitions), then we will tax US parent by deeming that CFC has paid a dividend to the US taxpayer
b. Prevents deferral of foreign source income that does not proceed from the active conduct of a trade or business in that foreign country
B. § 951 (Main provision)
1. Imposes the tax on the US shareholder (because we have no jurisdiction to tax the foreign company directly)
2. Taxes Subpart F income in foreign corporation as if it distributed that income to the US shareholder as a dividend
a. first fiction: the dividend was paid
3. To avoid § 951,
a. originally, could simply not have US shareholders, or have them hold non-voting stock or have the stock widely held
b. however, there are anti-abuse provisions now in place
(1) THUS, have to be willing to de-control the foreign corporation
c. Even if de-controlled, Congress could respond:
(1) Through Subpart F
(a) create a "tax avoidance" rule similar to that in the expatriation provision
(b) could also amend the US shareholder rule
i) eliminate the 10% requirement
ii) focus on defining CFC on the basis of characteristics that we're concerned about
(2) OR without amending Subpart F
(a) could expand § 183 (hobby loss where you balance income and deductions)
(b) establish new Reg. scheme similar to that of § 469 (passive activity)
4. Other anti-deferral provisions in the Code
a. Subpart F
b. § 469
c. PFIC Scheme (see § 951(f) and § 1293)
(1) complicated scheme that Abreu did not cover in class
5. Not concerned with investment in, e.g., factory in Caymans
a. because that is a real business activity
b. Caymans no longer a tax haven when conducting a trade or business there
6. Transfer Pricing only works when you have a viable business in that foreign country
a. irrelevant when you have a CFC with Subpart F income because all of the income will be taxed to the US parent, regardless of the separate prices in each country to the related parties
7. Where Subpart F applies, it's possible that you could have gotten the same result under § 482
a. Subpart F makes using § 482 in these situations unnecessary
C. Identifying Tax Haven Income (under § 954(d))
1. Dave Fischbein Manufacturing Co. v. Comm'r, 59 T.C. 338 (1972) 239
a. CFSA was a wholly-owned subsidiary of TP, incorporated in Belgium. CFSA bought certain parts from TP and tailored them to fit finished machines
b. I: Whether the income generated by CFSA from its sales of these machines is "foreign base company income" includable in the income of its US shareholder, DFC.
c. H: No. CFSA's operations are a significant major assembly of the machines, substantial in nature and constitute the manufacture of a product
d. Defin. of foreign base company sales income covers only transactions involving both a purchase and a sale
(1) it does not apply to income of a CFC from the sale of a product which it manufactures
e. Packaging, repackaging, labelling or minor assembly cannot be considered manufacture, production or construction for § 954 purposes
D. The Control Test (did not focus on in class)
1. CCA, Inc. v. Comm'r, 64 T.C. 137 (1995) 245
a. Old CCA (DE Corp) had a wholly-owned Swiss subsidiary (AG). After new CFC rules passed, Old CCA attempted to divest itself of 50% of its stock in AG
b. I: Whether AG remained a CFC after Old CCA transferred to foreign persons the voting preferred stock of AG, which had 50% of the total voting power
c. H: No. Old CCA successfully divested itself of 50% of the voting power of AG
d. Factors considered:
(1) No substantial restrictions on preferred stock that were not also on common
(2) No provisions for CCA to reacquire that stock should new shareholders sell it (ie., no reversion clause)
(3) Board of directors was equally divided between common and preferred
(4) Sold to non-related shareholders whose representatives took an active part in the business decisions
(5) Retained no significant strings
e. THUS: no retained dominion and control
E. The Branch Rule
1. Ashland Oil, Inc. v. Comm'r, 95 T.C. 348 (1990) 249
a. Ashland (previously US Filter) had a wholly-owned sub (Drew Ameroid) in Liberia (a tax haven) which was intended to avoid taxes. DA contracted with Tensia (a Belgium corp) for Tensia to manufacture products that DA sold in Liberia and outside.
b. I: Whether Tensia is a "branch or similar establishment" under § 954(d)(2) sufficient to attribute Tensia's income to DA (and then to Drew Chem. because DA is a CFC).
c. H: No. Tensia's relationship to DA bears neither the tax haven nor tax deferral stigma
(1) Perhaps different result if Tensia were in a tax haven country
d. Belgium is not the tax haven, Liberia is (Tensia's activities were in Belgium)
e. DA had no claim to Tensia's manufacturing income
(1) Nothing was thus retained in lieu of distributing dividends to US shareholders
f. This is a 3d party supplier bound under contract, nothing more.
g. Want to ensure same results if
(1) do business as a branch v. corp; OR
(2) which corp owns the branch
(a) doesn't matter because of the flush language in § 954(d)(3)
h. How would Belgium tax if Tensia were DA's branch?
(1) conduct of t/b in Belgium
(2) effectively connected
(3) taxable on that income in Belgium
(4) would have to be acting as DA's agency, then DA would be engaged in the conduct of a t/b etc.
i. Go through agency analysis
(1) 8% of Tensia's business was DA
(a) looks more independent, like Merryl Lynch
(2) who controls Tensia's output?
(a) DA gave raw materials
(b) DA gave intangibles
(3) DA assumes risk of loss
(4) BUT, Tensia will make a profit even if DA suffers a loss (it's in the contract)
(5) From US standpoint, this is usually treated as an agency relationship
j. Court seems to miss the point N54
(1) relies on Belgium not being a tax haven
(2) doesn't give weight to who owns the branch
(3) relies on dictionary to define branch
(4) Court was just plain wrong on the analysis (but these facts are not typical of the tax haven abuses Subpart F is concerned with)
F. Controlled Foreign Corporations v. Partnerships
1. See p. 4 for jurisdictional analysis
2. Brown Group v. Comm'r, 77 F.3d 217 (8th Cir. 1996) Supp.
a. Brown Group owns BGII (DE Corp), a sub that in turn owned a Cayman sub (BCL) which set up a limited partnership abroad to be a purchasing agent (Brinko).
b. I: Whether BCL's share of Brinko's partnership earnings was Subpart F income given that the commissions were not Subpart F income when Brinko earned them
c. H: No. The pre-1987 statute in effect required that Brinko be controlling BCL, when the reverse was true in fact
(1) Current statute has ownership going either way
d. Income is to be characterized at the partnership level and the income retains its character when distributed to the individual partners
e. Congress fixed this loophole in 1987, although not retroactively
(1) fn 24 on p. 19 (Supp) indicates that 8th Cir. believes that a partnership can never have Subpart F income (because can't be a controlled foreign corporation)
(2) suggests that the fix in 1987 was not enough
(3) Other circuits are free to disagree
f. Flush language of § 954(d)(3) ("directly or indirectly") allows you to attribute ownership from Brinko through to BGII to figure out if it's a related person
(1) § 958 actually contains the attribution rules
G. Tax Haven Abuses through Off-Shore Banks 265
1. did not cover in class
H. Comparative CFC Regimes 269
1. Tax Tables

VI. Overseas Americans
A. § 911
1. Provides an exclusion for foreign earned income for certain people
2. If you're the IRS, do not want § 7701(b) to apply for § 911 purposes
a. would act to allow TPs to exclude all foreign earned income
3. Qualified individuals must have:
a. tax home in foreign country; AND
(1) defined under Reg § 1.911-2(b) as: tax home is considered to be located at
(a) his regular or principal place of business; OR
(b) if the individual has no regular or principal place of business because of the nature of the business, then at his place of abode in a real and substantial sense
b. be bona fide resident of foreign country (Reg § 1.911-2(c))
(1) must be resident in foreign country for at least 1 year before can use § 911 (N60, Dean example)
B. Abode/ Tax Home Test
1. William R. Wilson v. Comm'r, TC Memo 1991-491 (1991) 295
a. TP worked on an offshore oil rig for 28-day periods, with an equivalent break in between which he spent at his home in GA (amounted to 6 months there and 6 months on the oil rig).
b. I: Whether TP's income from the oil rig was "foreign earned income" under § 911, and thus excludable from gross income
c. H: No. Because TP's tax home was not in a foreign country, he was not a qualified individual under § 911
d. § 911 only applies when
(1) TP's tax home is in a foreign country; and
(2) TP meets either:
(a) bona fide residence test; or
(b) physical presence test
e. Not a sympathetic case here
(1) no duplicative expenses
(2) no duplicative taxes
f. Ironic decision, though, because oil rig industry pushed hard for § 911 and statute is construed against them here
g. Abode defined: one's home, habitation, residence, domicile, or place of dwelling
C. Bona Fide Resident Test
1. George H. Jones v. Comm'r, 927 F.2d 849 (5th Cir. 1991) 298
a. Jones worked for a Japanese airline and lived in Japan for most of the time at issue. His wife chose to remain in Anchorage for the last 8 years of his career
b. I: Whether Jones was a qualified individual under § 911 and entitled to exclude his Japanese income from his US gross income
c. H: Yes. He was a bona fide foreign resident and his tax home was in Japan for those years
d. It is not necessary for TP to establish a fixed, permanent place of abode in order to be a "resident" of a foreign country
e. Factors to Be Considered (Should be balanced and weighed; not all must be present each time) (straight from language of Reg. § 1.871-2(b))
(1) intention of taxpayer;
(2) establishment of his home temporarily in the foreign country for an indefinite period;
(3) participation in the activities of his chosen community on social and cultural levels, identification with the daily lives of people and, in general, assimilation into the foreign environment;
(4) physical presence in the foreign country consistent with his employment;
(5) nature and duration of his employment; whether his assignment abroad could be promptly accomplished within a definite or specific time;
(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 his income tax status by his employer;
(9) marital status and residence of family; and
(10) good faith in making his trip abroad; whether for the purpose of tax evasion.
D. Difference between Abode (Tax Home) and Bona Fide Residence
1. Tax home: where the individual has his principle place of business
a. See Reg. § 1.911-2(b)
2. Bona Fide Residence: based on § 871 and Regs
a. See Reg. § 1-871-2(b) "Residence defined"
(1) "Resident" if not a transient
(2) Whether he is a transient is determined by his intentions with regard to the length and nature of his stay in that country
(3) A mere floating intention to return to another country is not sufficient to constitute him a transient
(4) One who comes to the country for a definite purpose which in its nature may be promptly accomplished is a transient; BUT
(a) if his purpose is of such a nature that an extended stay may be necessary for its accomplishment, . . . he becomes a resident, though it may be his intention at all times to return to his domicile abroad when the purpose for which he came has been consummated or abandoned. (Jones seems to be here)
(5) Etc.
E. Professorial Sabbaticals
1. Lynn W. & Eleanor T. Gelhar v. Comm'r, TC Memo 1992-162 (1992) 304
a. Husb. was MIT professor. Was granted a one-year sabbatical and travelled all over Europe, staying in Australia and New Zealand for 5 months.
b. I: Whether TP's home in New Concord, which they rented out for only 1 year constituted their tax home.
c. H: Yes. TP's employment in Australia and New Zealand was temporary and TP did not establish a tax home in either country. (THUS: was a sojourner or transient)
F. Vacation Home
1. Michael J. Wojciechowski v. Comm'r, TC Memo 1991-239 (1991) 306
a. TP owned a condo in Bahamas where he stayed with his second wife whenever he had a break from work. His job was based out of JFK airport and he was always expected to report there for his shifts.
b. I: Whether his time in Bahamas qualified to convert it to his tax home.
c. H: No. TP's decision to spend time abroad in Bahamas for personal reasons while remaining based in NYC for his work was the type of activity that § 911 contemplated not covering.
d. Congressional purpose: To help promote the export of US manufactured goods and services.
e. Tax home is located at regular or principal place of business.

Table of Contents

I. Jurisdiction to Tax 1
A. Based on Citizenship 1
2. Cook v. Tait 1
3. Rexach v. U.S. 1
B. Residence Jurisdiction over Aliens 1
1. Park v. Comm'r 1
2. Brittingham v. Comm'r 2
C. Analysis for Taxing Non-Citizens 2
D. Residence Jurisdiction Over Corporations 5

II. Taxation of Foreigners (INBOUND) 5
A. Income from Business Operations 5
1. Agency Relationship (in the form of Consignment) 5
a. Handfield v. Comm'r 5
2. US Subsidiary Deemed an Agent 6
a. Inverworld v. Comm'r 6
3. Partnerships 7
a. Cokes v. Comm'r 7
4. Trading in Securities 8
a. Higgins v. Comm'r 8
5. Check-the-Box Regs 8
B. Transfer Pricing: Tax Avoidance by Foreign-Based Entities 8
1. Related-Party Sale 8
D. Tax Treaties 11
2. Withholding 11
b. Aiken Indus. v. Comm'r 11
3. Capital Gains Exempted from Treaty 12
a. Botai Corp. v. Comm'r 12
4. Agent of "Independent Status" 13
a. Taisei Fire & Marine Co. v. Comm'r 13
5. Alternative Minimum Tax 14
a. Lindsey v. Comm'r 14
E. Branch Tax 15
2. Key: Dividend Equivalent Amount 15
3. Calculation (§ 884(b)) 15
4. Limitation § 884(b)(2)(B) 16
F. Expatriation 18
1. Furstenburg v. Comm'r 18

III. Source Rules 18
B. Identifying the Proper Source Rule 19
3. Services (§ 861(a)(3)) 19
a. Comm'r v. Peidras Negras Broadcasting Co. 19
5. Mixed Categories of Income (Services v. Sales) 20
a. Comm'r v. Hawaiian Philippine Co. 20
6. Royalties 20
a. Sanchez v. Comm'r 20
C. Allocation of Gross Income by Formula (Mixed Source Income) 21
1. Favell v. U.S. 21
2. Phillips Petroleum Co. v. Comm'r #1 22
3. Intel Corp. v. Comm'r 23
4. Phillips Petroleum Co. v. Comm'r #2 23
D. Source Rules Under Tax Treaties 23
1. Boulez v. Comm'r 23
E. Implications of Electronic Commerce 24

IV. Foreign Tax Credit 24
B. Identifying Creditable Taxes 24
2. Bank of America v. U.S. 25
D. Limitations on Credit 25
1. Policy 25
2. § 904 26
E. Deemed Paid Credit (§ 902) 27

V. Controlled Foreign Corporations 28
C. Identifying Tax Haven Income 29
1. Dave Fischbein Manufacturing Co. v. Comm'r 29
D. The Control Test 30
1. CCA, Inc. v. Comm'r 30
E. The Branch Rule 30
1. Ashland Oil, Inc. v. Comm'r 30
F. Controlled Foreign Corporations v. Partnerships 31
2. Brown Group v. Comm'r 31

VI. Overseas Americans 32
B. Abode/ Tax Home Test 32
C. Bona Fide Resident Test 33
D. Difference between Abode (Tax Home) and Bona Fide Residence 34
E. Professorial Sabbaticals 34
F. Vacation Home 34

Law Student Outline Tax Law USA

Calculate basis
Depreciation
Find gain or loss
Can you take gain or loss
Is it above or below the line
Is it ordinary or capital

GENENERAL BASIS

§1001(a) provides that gain or loss shall be the difference between the amount realized from a sale of property and the tax payer adjusted basis sold.

§1001(b) amount realized defined. Includes cash and fair market value.
§1011 states that adjusted basis means basis as proved in 1012, which is cost basis.

Mortgaged Property

On a non-recourse mortgage, the amount borrowed is included to determine basis (CRANE). When the mortgaged property is sold the mortgage amount is included in the amount realized. (CRANE).

DEATH BASIS

Under §1014, the basis to the estate is the FMV of the property at the time of death.

BASIS FOR GIFTS

§1015 (a) donees basis as the same as the donors basis at the time of the gift. (for gain on sale of gift). For loss, the donees basis is the donor’s basis or the FMV at the date of the gift, whichever is lower (§1015 (a)). Taft v. Bowers.

CAPITAL IMPROVEMENTS

This falls under §1016, you increase the basis by the amount of the expense, and you decrease it by depreciation.

DEPRECIATION

The depreciation tables are on page XV. §167 explains the eligible property. Includes exhaustion, wear, and tear on property used in trade or business or held for the production of income. Useful life must be definite and predictable. Not for land because that is indefinite life. It is limited to the taxpayers basis. §167(c) allows you to deduct depreciation from basis.

Under §168 (b), you have declining balance and straight line. Under declining balance method, the rate is 40%. Use declining balance until the amount would be lower than straight line, then switch to straight line. Look at the classification of the property under (e), to find how property is going to be treated, then go to (c) to find the applicable recovery year. Don’t forget to look at (d) to find the applicable convention. Look to (f) for property to which this article is not applicable, then look to (g) for alternative methods.

§179 deduction. Can only take the first year. Must be §1245 property used in a trade or business. Limited by §179(b)(2) & (3).

Capital Assets

§1221 tells you what a capital assets isn’t. §1222 divides capital assets into short term (held for one year or less) and long term (held for more than one year). You must hold the property more than one year to benefit from the reduced rate.

DEDUCTIONS

§161 and §162 (trade or business expense). Under §163, you get interest deduction. You can only deduct personal interest under §163(h), for trade or business or home equity loan. Look for limitations on deduction under §163 (j). You can deduct start-up expenditures under §195.
Under §262, you cannot deduct personal expenses. No deductions will be allowed for capital expenditures under §263. If you are repairing the property to continue the properties opertions for the duration of its expected life, it is not a capital expenditure. If you are lengthening the expected life, it is a capital expenditure.

You can take depreciation deduction under §167. Capital expenditures can be deducted through depreciation.

ALIMONY PAYMENTS

§71 gross income includes amount received as alimony or separate maintenance payments. Under §215, the payor gets a deduction for the payments. Look to §71(f) for front end loading. Look at Reg§1.71-1T. Alimony payments must be cash. §61(a)(8) says you can take alimony above the line. §1041 says transfer of property between spouses has no tax consequences.
§71(f): Figure out recapture in year two first. If the payment in the second year exceeds the payment in the third year by $15K, then there is recapture of that excess in the third year. If the alimony payments in the first year exceeds the average of the payment in the second and third year by more than $15K , that excess amount is also recaptured in the third year. If either spouse dies, there is no recapture under §71(f)(5)(A)(i).

Example: First Year - $80K 1. Take the third year payment and add $15K to it = $45K
Second Year - $80K 2. Take the second year payment and subtract it from the $45K=$35K
Third Year - $30K 3. There is a $35K recapture of the year two excess in year three.
4. As the payment for the first year ($80K) exceeds the average of the second
Year(as reduced by the second year recapture) and the third year. This is the average of $45k and $30K = $37.5k then add $15K = $52.5K. There is an additional $27..5K ($80K less $52.5) recapture from year one in year three. Thus the total excess alimony payments form year one and year two is $62.5K and that amount is recaptured in year three. The payor spouse must include the recapture amount in this GI, the payee can deduct.

§1041 – there is no gain or loss for transfer of property subsequent to a divorce.

ANNUITIES

If you paid $20k for $5k a year for life expectancy which is 25 years, you are getting $125,000. The $20k is your basis, so you should only be taxed on $105k. You have three options: 1) first $20k is not taxable; 2) first $105k is income; and 3) part is taxable and part is not. Take the annuitants investment and divide it buy the aggregate of the payments to be received (# of payments X amount of annual payment). The result is an exclusion factor. Take that fraction and multiply the annual payments. That amount is the return of capital, so subtract this number from the payment to find the amount that is taxed. Under §72(b) if the annuitant dies early, he can deduct his full un-recovered amount on his tax return. If he lives too long, he must include the entire amount in his GI.

Exclusion ratio: x = basis §72(c)(1)/ total payments (c)(3) . Multiply this ration by the payment.

ACCOUNTING METHODS
§441 – taxable year is the taxpayer’s annual accounting period, if it is a calendar year or a fiscal year. §446 is methods of accounting, which can be cash method or accrual method. §451 tells you when the gross income will be included in gross income. §461 – general rule for taxable year of deductions. §465 – deduction limited to the amount of risk.

ALTERNATIVE MINIMUM TAX

§56(b)

FLOW CHART FOR LOSSES

§165 see if the loss fits in here. If yes, go to §267 to look for a roadblock. Look at §162 for t or b, or §212 for production of income. Look to see if it is an ordinary loss or capital loss. §1221, 1231, 1245. Always look at §1245 before §1231.

DETERMINING GAIN

§1001(a) is realized. 1001(c) is recognized. Then look at basis, §1012 (cash basis), §1014 (step up basis for death benefits), §1015 (gift basis)(Reg. 1.1015-4), §1016 (adjustment to basis)(got to §263 [capitalization] or §168 [depreciation]). Then go to §1031(c) which is like kind and exchange (tax shelter). Watch out for exchange of property and cash (boot). See Reg 1.1013 (d)(2), how to do like kind exchanges when boot or cash involved. See if it is an ordinary or capital.

MISCELLANEOUS

§465 – non-qualified non-recourse debt is not included in your basis if it is not at risk.

Part-gift/part sale = look at Reg 1.100-1(e). Then go to Reg1.1015-4 for basis.

Depreciation
§168(e) calssifies property. §168(d)(1) sends you to 168(d)(4).

When taking §179, don’t forget to reduce “dollar limitation” by §179(b)(2).

INSTALLMENT METHOD

Can only be used for cash accounting method. The essence of 453 is how much is taxed and how much is returned to basis.
Formula (453 c ): Income recognized (x)/ Payment in the first year = Gross profit (selling price – adjusted basis)/ Total Contract Price. Take the fraction and multiply it by the payment. That is the amount that you will pay in taxes, the leftover is allocated to basis. Good example on page 1418.

280A

280A(a) – generally no deductions are allowed with respect to residence. Exceptions under (c), (c)(1) says that business deductions will be allowed, but check the list. This deduction is limited by (c)(5). It creates a fraction. It is gross income (c)(5)(A) over (B)(i) and (B)(ii). (B)(i) are deductions like 163(h) and 164 (these are things you could take even if not used for trade or business). (B)(ii) are deductions like 162 (things attributable to the business) and this should be multiplied by X/365. (5) you can’t have deductions that exceed your gross income. You can only deduct a certain amount this year and can carry the rest over till the next year.

Example: Income from Rent $10,000 e(2) = days rented/365 x regular allowed deductions
Property Tax $ 1,000 Regular deductions = tax and interest
Interest on Mort. $ 1,000 Subtract this number from the income to get “N”, which you
Utilities $2,000 will use later.
Depreciation $ 3,000 Under ( c )(5), days rented/total pers. days + days rented x expenses.
Multiply this ratio by the business expenses (utili. & deprec)
Days rented 100 Subtract that total of the two from “N” and this gives you the
Days personal 20 max amount you can deduct. (remember about carryover next year)

LIMITS ON PASSIVE ACTIVITY LOSSES AND CREDITS

Divide the income by sources. Three categories: 1) active; 2) portfolio; and 3) passive. Passive activity loss is not deductable. Look at (d)(1), passive activity loss is the amount by which the aggregate losses from all passive activities for the taxable year exceed the aggregate income from all passive activities for the taxable year. Look at (e)(1) to see certain incomes that are not treated as income from passive activity. Under (f), you can carry over passive losses that you couldn’t take the year before. Look at (g) if you dispose of your entire interest in a passive activity. Look at (j) for special rules.

PRACTICE PROBLEM #2

Karent’s AB in the old machine is $100k (1012, Crane, & Tufts)

Issue #1 – The $1k istallation is a capital expenditure under (263)(1.263(a)(2)), (Indopco)

Issue#2 - $4k adjustment expense is a capital expense because it extens the life, adds to the value, or changes the property use.

Issue #3 - $300 repair – This is a business deduction under (162), (1.162-4), and this deduction is taken above the line under (62).

Issue $4 – Depreciation of the item under (167)(168)
• Go to (179) and then to (1245) to seeif it is 1245 property – if it is, then you can take the 179 deduction first before anyk depreciation
• You get a new AB when you add on the $4k (1016, 1012, 263), which is $104k.
• Subtract the 179 deduction and begin the depreciation.

Issue #5 – You have a new AB after depreciation – now we look to (1031) because we may have an exchange of like-kind property.
• Karen is receiving a new machine ($130k) and a realease of $60k of debt, so her amount realized is $190k.
• The other person is getting $75k for the old machine (FMV), $25k in cash, and a note for the remainder for $90k which equals $190,000.
• Next, figure out the net fair market value

Karen $75k (FMV of old machine) Other party $130k (new machine)
$60 (mortgage) $0
$15 (net FMV) $130k (net FMV)

• At this point, the other party needs $115k to make up the difference – it got $25k of cash, so now they need $90k to make up the difference.
• Now figure out the gain or loss – AR for Karen is $190k ($130k + $60k) and her AB is figured to be $63 (old basis) plus $25 (cash she paid out) plus $90k (her new note) equals $178k.
• $190k minus $178 = $12 of gain (1001(c))

Issue #6 – Now we look at (1031), look at each side seperatly

• Like kind property transfer (1.1031 (a)(2))
• Now look for Karent’s boot – she has $60k of potential boot (from release of debt) which may be washed.
• Under (1.1031 (b)(1)(c)), you wash this boot by taking on another obligation or money (she took on a $90, note and paid $25 cash) she may wish this here
• Other party’s AR is $75k (FMV of old machine they are taking), $25k (cash received from Karen), and $90k (note from Karen)
• Other party’s boot is $25 (cash received) and $90k (new note) for a total of $115k, can they wash this?
• So Karen has no gain at all under (1031)(a).

Issue #7

What is Karen’s basis on this new machine?

• Formula is Old basis – loss released from + recognized gain – recognized loss
• So Karent’s old basis as adjusted (1016) is $63k + $90k (new liability) + $25K )cash paid out) minus $60k (relieved loss) + $0 (recognized gain) minus $0 (recognized loss) = $118k (new basis).

Issue #8

Is this gain/loss capital or ordinary?
Go to §1221 and §1245, go to §1245 first.

• Look for recapture under 1245 for this type of problem.

CAPITAL GAINS OR LOSSES

Go to §1221, defines a capital asset. §1222 says that it must be a “sale or exchange” to be a capital asset. §1211(b), capital losses are limited to the gains on such exchanges less $3k. §1231 deals with business property, if it is depreciable business property, go to §1245 first, it trumps 1231. §1245 (a)(3) is the definition of §1245 property. Whatever gain exceeds the adjusted basis is ordinary gain, anything below that or equal to that is a capital gain. $200 gain from 1245 property, with a basis of §100. $100 is ordinary gain, and the other $100 is capital gain (1245 a 1). Losses are governed by §1231, this is hotchpot. If the capital gains exceed losses than everything is capital. If losses exceed gains, then everything is ordinary.