Bus 225D – International Transactions II Instructor: Carol Rutlen, CPA

2 US anti-abuse provisions –FIRPTA –FPHC –CFC –PFIC Agenda for Class 8

3 General Rules of Taxation US citizen Resident alien Nonresident alien Corporation –Shareholders taxed on dividends received –Shareholders taxed on gain on sale of stock

4 US anti-abuse provisions Foreign Investment in US Real Property (FRIPTA) §897 and §1445 Foreign Personal Holding Companies (FPHC) § Controlled Foreign Corporation (CFC) and Subpart F Income § Passive Foreign Investment Company (PFIC) §1297

5 FIRPTA NRA owns US real estate §871 – Tax on Nonresident Alien –§871(a) income not connect with US business – 30% tax –§871(b) income connected with US business – graduated rates Before §897 added capital gain on US real estate not taxed to NRA Establishes similar treatment to tax on US citizen

6 Disposition of Investment in US Real Property Applies to NRA and foreign corporation Treated as effectively connected income §897(a)(1) Interaction with §871(d) – election to treat real property as effectively connected income

7 US Real Property Interest (USRP) §897(c)(6) defines – real property land, improvements, buildings, personal property associated with the use of real property Located in US or Virgin Islands Interest in domestic corp whose assets consist principally of USRP –Corporation included because disposition of corp wouldn’t generate tax –When domestic corp has USRP interests having an aggregate FMV that equals or exceeds 50% of the FMV of the corp real property and business assets

8 Coordination with Nonrecognition Provisions Certain nonrecognition provisions trigger §897 Nonrecognition exchanges –Exchange like-kind property –Acceptable if property given and property received are USRP interests Capital contributions to foreign corporation

9 Computation of §897 Tax Effectively connected income Character of gain – capital vs. ordinary Deductions for losses may be limited

10 §1445 Withholding of Tax on USRP §1445(a) transferee required to deduct and withhold a tax equal to 10% of the amount realized –Transferee – person acquiring the USRP –Transferor – person disposing of USRP Amount realized –Cash paid or to be paid (excluding interest) –Market value of other property transferred or to be transferred –Amount of liabilities assumed by the transferee –Amount of liabilities which the transferred property was taken subject to

11 Example X sells a USRP interest for $10 in cash to Y Y agrees to take the property subject to a $90 mortgage What is amount realized? How much must Y withhold?

12 Exceptions Transferor furnishes affidavit that the transferor is not a foreign person and provides taxpayer ID# Residence where amount realized does not exceed $300,000 §1443(c) modify 10% withholding –IRS must issue a withholding certificate specifying the transferor’s maximum tax liability –If transfer is completed before certificate issues, IRS will refund to transferor the excess tax withheld

13 Process NRA sells USRP interest Escrow agent in US withholds 10% tax and files Form 8288-A NRA files Form 1040NR to report the sale

14 FPHC Enacted in 1937 –Individuals established foreign corp for investments –Does not apply to foreign corp that is a subsidiary of a widely-held domestic corp 1962 enacted Subpart F –Taxes US shareholders on certain earnings of CFC –May overlap FPHC rules – Subpart F rules control 1986 enacted PFIC –US person owning stock in a foreign investment vehicle must either report share of the company’s earnings currently or pay interest on the deferral FPHC repealed - tax years after 12/31/04

15 CFC > 50% of stock, by vote or value, is owned by US persons (both individual and corp), counting only people who own at least 10% of the voting stock Taxation of foreign corporation – US tax on non-US income deferred as long as income stays outside US Shareholder taxed on ratable share of Subpart F income as a dividend File Form 5471

16 Subpart F Income Dividends, interest, royalties, and other passive income Income from sales of goods where the foreign corp either buys the goods from or sells them to or on behalf of a related person Income from services performed for or on behalf of related persons Income from shipping operations

17 Investments in US Property Shareholders taxed when earning of CFC deemed invested (directly or indirectly) in US property –Debt obligations –Certain receivables –Stock –Tangible US property –Intangibles

18 PFIC Taxpayers tried to get around through minority ownership - tax avoidance US investors in domestic mutual funds taxed currently on funds investment income –Domestic fund must distribute at least 90% of its income each year to avoid US tax at corp level Foreign mutual funds could avoid US taxation –No dividend distributions –All capital gain when sell fund

19 PFIC §1297 –75% or more of its income is passive or –50% or more of its assets produce passive income Proportion of stock held by US person is not relevant US persons – US citizens and residents, domestic corp, partnerships, trusts, and estates

20 PFIC Can elect to make PFIC a pass through entity (similar to mutual fund) If don’t make election –Tax deferred until dividends are distributed or stock is sold, but imposes interest on tax due –“Interest” triggered by disposition of PFIC stock or excess distribution File Form 8621 Not applicable to California

21 Anti-Avoidance Provisions No deferral of tax on passive investments Allocate income to low tax rate jurisdictions Convert ordinary income to capital gain Making investments in US rather than paying dividends Investments in US real property

22 US anti-abuse provisions –FIRPTA –FPHC –CFC –PFIC Final –Open book –Topics Final class Class evaluation Key Points