Cole, Robert T.

Halphen, Christine

English

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International Aspects of Tax Laws with Respect to Foreign Investment in the United States: An Outline-Summary

Southern Methodist University

ROBERT T. COLECHRISTINE HALPHEN*International Aspects of TaxLaws with Respect to ForeignInvestment in the United States:An Outline-SummarytUnited States taxation of foreign direct investment in the United Statesdepends primarily on (1) status of the investor as a resident or nonresident forU.S. tax purposes and (2) type of income derived by the foreign investor. TheU.S. tax rules can be modified by tax treaties.I. Residence for U.S. Tax Purposes: Definition and EffectA. Definition1. Individuals: Test is physical presence coupled with intent to reside in theUnited States. As a rule of thumb, one year of continuous presence would con-stitute residence.2. Corporations: Test is the place of incorporation. Also, a foreign corpora-tion (i.e. incorporated in a foreign country) which is << engaged in a trade orbusiness within the United States > is treated as a resident corporation but to alimited extent only.3. Partnership, Trust and Estate.B. EffectAn entity or individual treated as a resident of the United States is taxed onworldwide income while an entity or individual treated as a nonresident istaxed to a more limited extent and depending on the type of income received.*Of Cole, Corette & Bradfield, Washington, D.C.tEditorial Note: Other tax aspects of foreign investment in the United States, such as the impactof state income taxes, federal estate taxes and Social Security, which were likewise considered,were not included in the outline-summary made available for publication.428 International Lawyer, Vol. 12, No. 2ABA Conference Papers in Nice 4291I. U.S. Taxation of a Foreign InvestmentA. General RulesA nonresident individual or entity investing in the United States can derivethree types of income which receive different tax treatment.1. Passive investment income: Consists essentially of dividends, interest,rents and royalties.-Such income is subject to a withholding tax in the United States providedit is from U.S. sources.-Tax is imposed on the gross amount at a flat 30 percent rate.-Rate can be reduced or eliminated by tax treaties. The following rates aretypical of U.S. tax treaties:" Interest: 0 to 15 percent" Royalties: 0 to 15 percent" Dividends: 15 percent (on portfolio investment) or 5 percent (on corporatedirect investment).2. Income which is effectively connected with a U.S. trade or business.a. U.S. trade or business: Depending on the type and amount of business ac-tivities in the United States by the foreign investor, such activities can amountto the << conduct of a trade or business within the United States >>In case of treaty country residents, U.S. trade or business must be through apermanent establishment. Tougher rules apply to entertainment business.Treaties typically require factual connection.b. Effectively connected income: Includese All U.S. source business income. Treaties typically require factual connec-tion.* All U.S. source passive income which is factually effectively connectedwith U.S. trade or business. Example of each.* Certain foreign source income under U.S. technical tax rules that is earnedby U.S. business. Could have changed source rules, but chose to do it this way.Limited to three types: (1) foreign rents or royalties actively derived by U.S.business and capital gains on such property; (2) interest or dividends activelyderived by U.S. banking, financing or securities trading business and capitalgains on such property; (3) certain sales income where U.S. office is active buttitle passes outside the United States so that source is foreign.c. Taxation: Such income is subject to tax rules similar to those applicableto residents of the United States (Rates. Deductions and the problem of alloca-tion. Carryback and carryover of losses. Capital gains and losses. Tax credits.)3. Business income not amounting to U.S. trade or business: Free of U.S.tax. In the case of treaty country resident, business income is free of tax ifthere is no permanent establishment. Primarily sales income and service fees ofcorporations.International Lawyer, Vol. 12, No. 2430 INTERNATIONAL LA WYERB. Specific Tax Issues1. Organization and liquidation of investment: Investment structured as aU.S. subsidiary can be organized and liquidated free of U.S. income tax.Special aspects of liquidation of real estate investment.2. Reallocation of income: Section 482 of the Internal Revenue Code.Scope and enforcement.3. Compensation earned by nonresident alien individuals.a. The 90-3,000 rule: Compensation received by a nonresident alien for per-sonal service performed in the United States is exempt from tax in the UnitedStates if the individual (1) is present in the United States for a period duringthe taxable year not exceeding 90 days, (2) does not receive more than $3,000as compensation and (3) performs the service under a contract with a foreignperson. If the individual fails to meet any of these three requirements then:-The individual is considered to be engaged in a U.S. trade or business.-Compensation income is considered to be effectively connected with aU.S. trade or business.-Presumably, his foreign employer is also deemed to be engaged in a U.S.trade or business.b. Tax treaties modifications: Typically U.S. tax treaties extend the periodof physical presence to 183 days and eliminate the limit on the amount of com-pensation as well as the requirement of a contract with a foreign person.International Lawyer, Vol. 12, No. 2

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International Aspects of Tax Laws with Respect to Foreign Investment in the United States: An Outline-Summary

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