U. S. Income Taxation Of
International Activities

International Topics
• Sourcing of income
• “U. S. Persons” and “Foreign
Persons”
• Taxation of Foreign Persons
• Controlled Foreign Corporations
• “Grossing up” of Dividends
• Deduction and Credit for Foreign
Income Taxes
• Foreign Earned Income
Exclusion

Several Tax
Strategies
related to
International Tax to demonstrate these issues

Sourcing Of Income
• Determining the “source” of income frequently determines whether the income is taxable in a jurisdiction but it is not necessarily conclusive
• The source of income computation also affects other computations.

U. S. Source Income
U. S. Source
Income

Foreign Source
Income

Reportable in U. S.

Reportable in U. S.

Usually Reportable in
U. S.

Not Reportable in U. S.

U. S. Person
A citizen or resident of the United
States
A domestic partnership
A domestic corporation
Any estate other than a foreign estate Certain Trusts

Foreign Person
Nonresident alien individual
Foreign corporation
Foreign partnership
Foreign trust
A foreign estate

This is focus of next few slides Sourcing Examples
Item of Income

Factor Determining Source

Salaries, wages, other compensation

Where services performed

Business income:
Personal services

Where services performed

Business income:
Sale of inventory—purchased

Where sold

Business income:
Sale of inventory—produced

Allocation

Interest
Sale of real property
Non-business personal property

Residence of payer
Location of property
Residence of Taxpayer

U. S. Tax Treatment of U. S Source
Income Earned by Foreign Persons
Income Effectively Connected with a
U. S. Trade or Business
Taxable income (after deductions is taxed at U. S. rates

Fixed and Determinable Annual or
Periodic Income
Gross income is taxed at flat rate (30% or lower rate determined by treaty)

Questions - Sourcing
Item of Income
Income earned in a 3 week stint in Las
Vegas by an entertainer who is a citizen and resident of France
Income earned in a 3 week stint in
Monaco by an entertainer who is a citizen and resident of the U. S.
Gain from sale of real property located in
Germany by citizen and resident of U, S.
Gain from sale of real property located in
U. S. by citizen and resident of Germany.
Gain from sale of common stock transacted on the NYSE by citizen and resident of Germany.
Gain from sale of common stock transacted on the Frankfurt stock exchange by citizen and resident of the U.
S.
Cash interest from a U, S, corporation paid to a citizen and resident of Germany

Source

Treatment in U. S.

Summary of U. S. Taxation Of
Foreign Persons
• Generally not taxed in U. S. unless they have U. S. source income.
• If they have U. S. source income by statute, “effectively connected” income is taxed at regular U. S. rates and “FDAP” income is taxed at fixed rate or treaty rate.
• U. S. payers are generally required to withhold on FDAP paid to foreign persons

Strategies
• Given the rules we just looked at, can
American companies and individuals take advantage of them?

Strategy One
• U. S. entity operates a branch office abroad instead of a corporation

• Result
– Income from branch office may be taxable in foreign location – Income from branch office is taxable in U. S.
– Losses from abroad deductible on U. S. tax return

Strategy Two
• U. S. entity operates a business activity abroad in a separate foreign corporation
• Result
– Non-U. S. source income will* not be taxed in U. S.
– U. S. company taxed when dividends are distributed to U. S. company
– Since foreign corporations cannot be consolidated on
U. S. returns, foreign losses cannot be used on U. S. return *Assuming usual rules we just looked at.

Strategy Three
• U. S. Corporation establishes foreign entity in low tax regime to service foreign market. The U.
S. Corporation then sells inventory at a low cost to the foreign sub for resale abroad.
• Result
– U. S. company may be able to “shift income” from a
“high tax” regime to the lower tax foreign regime