To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CHAPTER TAXATION OF INTERNATIONAL TRANSACTIONS SOLUTIONS TO PROBLEM MATERIALS Question/ Problem 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 *25 26 *27 *28 29 30 31 32 33 34 Learning Objective LO LO LO LO LO LO LO LO LO LO LO LO LO LO LO LO LO LO LO LO LO 3, LO 3, LO 1, 3, LO 4, LO LO LO LO 3, LO LO LO LO LO LO Topic Worldwide income Worldwide income Tax treaties Sourcing of income Sourcing of income Section 482 Foreign currency QBUs Section 988 gain or loss Section 367 Foreign Corporation CFC status CFC status Definition of CFC Foreign tax credit limitation Foreign tax credit or deduction Section 902 credit Foreign tax credit (FTC) issues FTC baskets of income Inbound taxation U.S taxation of foreign corporation Inbound versus outbound activities Worldwide taxation and the FTC Deferral of foreign income Income sourcing Income sourcing Income sourcing Income sourcing Income sourcing Income sourcing Interest expense allocation Interest expense allocation Foreign exchange gain or loss QBUs and functional currency Status: Present Edition Unchanged Unchanged New New Unchanged Unchanged New New New New New New Unchanged Unchanged New New Modified Unchanged New New Modified Unchanged Modified Modified Modified Modified Modified Modified Unchanged Unchanged Modified Modified Modified Modified Q/P in Prior Edition 13 14 16 18 21 22 23 24 25 26 27 28 29 30 31 32 33 34 Instructor: For difficulty, timing, and assessment information about each item, see p 9-4 9-1 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 9-2 Question/ Problem 2012 Corporations Volume/Solutions Manual Learning Objective 35 36 37 38 39 40 41 42 43 44 45 46 47 *48 49 50 51 52 53 54 55 56 *57 58 59 60 61 *62 63 LO LO LO 4, LO 4, LO LO LO LO LO LO LO LO LO LO LO LO LO LO LO LO LO LO LO LO LO LO LO LO LO 4, 64 65 *66 *67 68 69 70 71 *72 *73 74 75 76 77 LO LO 3, 4, LO LO 2, LO LO LO LO LO LO LO LO LO LO Topic QBUs and functional currency QBUs and functional currency Foreign exchange: branch income Foreign exchange gain or loss Export sales Section 367 Section 367 Section 367 Section 367 Definition of a CFC Subpart F income Pro rata share of CFC income PFIC Foreign tax credit (FTC) Foreign tax credit limit Foreign tax credit limit Foreign tax credit limit Deemed paid foreign tax credit Deemed paid foreign tax credit Deemed paid foreign tax credit Deemed paid foreign tax credit Foreign tax credit limit Foreign tax credit (FTC) Foreign tax credit (FTC) Foreign source losses (FTC) Section 902 credit and withholding tax Indirect FTC Foreign tax credit (FTC) Measuring deemed-paid taxes in foreign currency Losses and FTC Investment through foreign corporation Analyze foreign investment opportunities Tax liability of foreign corporation Effectively connected income Effectively connected income Effectively connected income Branch profits tax NRA’s sale of USRPI NRA’s sale of stock under FIRPTA Expatriation to avoid tax Dividend withholding tax Dividend withholding tax Dividend withholding tax Status: Present Edition Q/P in Prior Edition Unchanged Unchanged Modified Modified New Unchanged Modified Modified Unchanged Unchanged New Modified Unchanged Modified Modified Modified Modified Unchanged Unchanged Unchanged Unchanged New Unchanged Unchanged New New Unchanged Unchanged Unchanged 35 36 37 38 61 62 63 Unchanged Unchanged Unchanged Modified Unchanged Modified Unchanged Unchanged Unchanged Unchanged Unchanged Unchanged Unchanged Modified 64 65 66 67 68 69 70 71 72 73 74 75 76 77 40 41 42 43 44 46 47 48 49 50 51 52 53 54 55 57 58 *The solution to this problem is available on a transparency master Instructor: For difficulty, timing, and assessment information about each item, see p 9-4 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Taxation of International Transactions Tax Return Problem Topic 9-3 Status: Present Edition Q/P in Prior Edition Foreign tax credit (Form 1118) Foreign tax credit (Form 1118) Unchanged Unchanged CFCs and foreign base company income Trade or business in U.S Internet activity Internet activity Internet activity Internet activity Unchanged Unchanged Unchanged Unchanged New Modified Research Problem 6 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 9-4 2012 Corporations Volume/Solutions Manual Question/ Problem Est’d completion time Difficulty Easy Easy Easy Easy Easy Easy Easy 5 5 5 Assessment Information AICPA* AACSB* Core Comp Core Comp FN-Measurement FN-Reporting FN-Reporting FN-Reporting FN-Reporting FN-Reporting FN-Measurement | FNReporting FN-Reporting FN-Reporting FN-Reporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement FN-Measurement FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Reporting 10 11 Easy Medium Medium Medium 10 10 10 12 Medium 10 13 Easy 14 15 16 Easy Easy Easy 5 17 Easy 18 Medium 19 Easy 20 21 Medium Medium 10 10 FN-Measurement | FNReporting FN-Reporting FN-Reporting 22 Medium 10 FN-Reporting 23 Medium 10 24 25 26 Easy Easy Easy FN-Measurement | FNReporting FN-Reporting FN-Reporting FN-Reporting 27 28 Hard Medium 15 10 29 30 31 Easy Easy Hard 5 15 10 5 5 FN-Reporting FN-Measurement | FNReporting FN-Reporting FN-Reporting FN-Measurement | FNReporting Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Communication | Analytic Analytic Analytic | Reflective Thinking Analytic Analytic Analytic Analytic Analytic | Reflective Thinking Analytic Analytic Analytic | Reflective Thinking Communication | Analytic Communication | Analytic Analytic Analytic Communication | Analytic Analytic Analytic Analytic Analytic Analytic *Instructor: See the Introduction to this supplement for a discussion of using AICPA and AACSB core competencies in assessment © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Taxation of International Transactions Question/ Problem Difficulty Est’d completion time 32 Medium 15 33 Easy 34 Medium 15 35 36 37 Easy Easy Easy 10 10 38 Easy 39 40 41 Easy Medium Medium 15 10 42 Medium 10 43 Easy 44 Medium 10 45 Medium 10 46 47 Medium Medium 10 20 48 Hard 20 49 Medium 10 50 51 52 53 Easy Easy Easy Medium 5 10 54 Easy 10 55 Easy 56 Medium 10 57 58 Medium Medium 10 15 5 9-5 Assessment Information AICPA* AACSB* Core Comp Core Comp FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement FN-Measurement FN-Measurement FN-Measurement | FNReporting FN-Measurement FN-Reporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Reporting FN-Measurement FN-Reporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement FN-Measurement | FNReporting Analytic Analytic Communication | Analytic Analytic Analytic Communication | Analytic Analytic Analytic Analytic Analytic Analytic Communication | Analytic Analytic Analytic Analytic Communication | Analytic Communication | Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Communication | Analytic *Instructor: See the Introduction to this supplement for a discussion of using AICPA and AACSB core competencies in assessment © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 9-6 2012 Corporations Volume/Solutions Manual Question/ Problem Est’d completion time Difficulty 59 Medium 10 60 Medium 10 61 Easy 62 Medium 10 63 Easy 10 64 65 Medium Medium 10 20 66 Hard 20 67 Medium 10 68 69 70 71 Easy Easy Easy Medium 5 10 72 Easy 10 73 Easy 74 Medium 75 76 77 Easy Easy Easy 15 5 Assessment Information AICPA* AACSB* Core Comp Core Comp FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Reporting FN-Reporting FN-Reporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement FN-Measurement FN-Measurement Analytic Analytic | Reflective Thinking Analytic Analytic Analytic Analytic Communication | Analytic Communication | Analytic Analytic Analytic Analytic Analytic Communication | Analytic Analytic Analytic Communication | Analytic Analytic Analytic Analytic *Instructor: See the Introduction to this supplement for a discussion of using AICPA and AACSB core competencies in assessment © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Taxation of International Transactions 9-7 CHECK FIGURES 25.a $3,000 U.S.-source 25.b $6,000 U.S.-source 25.d $600 U.S.-source 26 $200,000 U.S.-source income subject to U.S taxation 28.a Foreign-source 28.b $45,000 U.S.-source 28.c U.S.-source 31 $20,000 32 $288,462 (tax book value method) 33 $0 38 $11,111 dividend; $0 exchange gain/loss 41 Inventory $30, machinery $30 45 $750,000 Subpart F income 46 $263,014 48 $204,000 49 $170,200 50 $150,000 51 $5 million 53 $1.75 million 54 $187,500 55 56 57 59 60 61 62 63 64 66 67 68 69 70 71 72 73 75 76 77 $20,000 $0 FTC allowed $68,300 U.S tax liability $20,000 passive basket numerator $13,000 gross income from dividend Allowed in d only $75,000 $52,632 $64,000 Invest in the stock Exco (6% return vs 4.62% return) $4,138,500 $0 ECI $1,009,000 $0 ECI $75,000 BPT Taxed on gain realized on sale of Jeff stock Gain not taxable $150,000 $60,000 $80,000 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 9-8 2012 Corporations Volume/Solutions Manual DISCUSSION QUESTIONS U.S persons are taxed on all income from whatever source derived (§ 61) Consequently, both U.S.- and foreign-source income is subject to U.S taxation Some of the U.S tax may be offset by available foreign tax credits p 9-3 No Unless and until the profits of the foreign corporation are repatriated to the U.S owner, such profits are not subject to U.S taxation The foreign corporation is not a U.S person (even though owned by a U.S person) Keep in mind that Subpart F income may trigger taxation as a “deemed” dividend before actual dividends are paid pp 9-20 and 9-21 Investment income such as dividends and interest typically is subject to a withholding tax when earned by a nonresident of a country Income tax treaties often reduce the rate of local tax withholding on investment income p 9-5 Dividends paid by a foreign corporation may be partially U.S.-source income The level of U.S.-source income earned by the foreign corporation is 25% or greater of the corporation’s base period income p 9-6 and Example TAX FILE MEMORANDUM Date: December 6, 2011 To: U.S Corporations From: Heather Davies Subject: Sourcing Internet income Sections 861-865 and the regulations thereunder provide specific rules for sourcing different types of income These rules provide a basis for sourcing interest, dividends, rents, royalties, personal services income, transportation income, space and ocean income, inventory sales, and international communication income However, the sourcing of income derived from Internet activities is not specifically addressed by the Code or regulations Although not specifically addressed, Internet income can be sourced by analogy to the rules for other types of income Two questions must be addressed to determine the source of Internet income • What is the nature of the income? • Where does the economic process generating the income take place? If the Internet income is related to the sale of products, the income should be sourced using the inventory rules, or where title to the inventory passes If the Internet income is related to the performance of a service, the income should be sourced using the service rules, or where the services are performed If the Internet income is from the use of an intangible asset, the income should be sourced using the royalty rules Unfortunately, the nature of Internet income is often uncertain leaving application of these specific rules awkward at best Tax authorities around the world are just beginning to grapple with the 21st century issue of tax policy and cyberspace Until more specific guidance is provided, careful application of existing sourcing rules to Internet income will be required pp 9-5 to 9-9 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Taxation of International Transactions 9-9 Section 482 is used by the IRS to prevent taxpayers from arbitrarily manipulating the source of income and the allocation of deductions This provision gives the IRS the power to reallocate gross income, deductions, credits, or allowances between or among organizations, trades or businesses owned or controlled directly or indirectly by the same interests This can be done whenever the IRS determines that reallocation is necessary to prevent the evasion of taxes or to reflect income more clearly pp 9-10 and 9-13 A qualified business unit is required to use the U.S dollar as its functional currency under § 985 unless it can demonstrate that a different currency should be used p 9-14 A qualified business unit (QBU) is a separate and clearly defined unit of a taxpayer’s trade or business A separate branch is usually a QBU A single taxpayer may have multiple QBUs For example, one corporation may have a manufacturing branch that is a QBU and a sales branch that is a separate QBU Each QBU may use its own functional currency pp 9-14 and 9-15 If a U.S taxpayer that uses the U.S dollar as its functional currency sells inventory on account for a price denominated in a currency other than the U.S dollar, the taxpayer records the income based on the exchange rate at the time of the original sale When the taxpayer collects the account receivable at a later date, the exchange rate between the U.S dollar and the foreign currency may have changed This difference will produce a currency exchange gain or loss For example, the taxpayer may sell inventory for 600 € at a time when $1:1.2 € The taxpayer records income of $720 (600 € × 1.2) Assume that the exchange rate is $1:1.25 € when the taxpayer collects the 600 € receivable 25 days later The 600 € generate $750 in U.S dollars (600 € × 1.25) The difference between the $750 collected and the $720 originally reported is a $30 § 988 currency gain p 9-15 10 If a U.S taxpayer transfers assets outside the United States, gain may be recognized as a result of appreciation in these assets The general rule under § 367 is that any gain will be recognized in such a transfer However, several exceptions exist, including an exception for assets used in a trade or business outside the United States Even with this exception, certain assets will trigger gain These include inventory and accounts receivable pp 9-17, 9-18, and Example 14 11 TAX MEMORANDUM Date: November 3, 2011 To: U.S Client From: Karen Whelan Subject: Foreign subsidiary generates U.S taxable income U.S taxpayers have attempted to avoid U.S taxes by placing their activities into offshore corporations Whether this approach shelters any income for the U.S taxpayer depends on the nature of the income/activities If a U.S taxpayer places investments inside a foreign subsidiary, this corporation may be a Controlled Foreign Corporation (CFC) The investment income from a CFC is taxed each year to the U.S shareholder, thus disallowing any deferral (or sheltering) of income from U.S taxes © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 9-10 2012 Corporations Volume/Solutions Manual If the subsidiary’s activity is an active business carried on outside the United States, the U.S owner of the foreign corporation may achieve deferral from U.S income taxes so long as the business profits are not repatriated back to the United States However, special rules exist under Subpart F that may cause current U.S taxation of the CFC’s income attributable to the U.S shareholder In summary, a U.S taxpayer may use a foreign corporation to hold certain activities/assets in order to avoid current U.S taxation However, if the non-U.S corporation is treated as a CFC, the U.S tax law removes this deferral on most types of income pp 9-21 to 9-26 and Concept Summary 9.2 12 For a foreign corporation to be a CFC, more than 50% of the total combined voting power of all classes of stock entitled to vote or the total value of the stock of the corporation must be owned by U.S shareholders on any day during the taxable year of the foreign corporation For purposes of determining if a foreign corporation is a CFC, a U.S shareholder is defined as a U.S person who owns, or is considered to own, 10% or more of the total combined voting power of all classes of voting stock of the foreign corporation Stock owned directly, indirectly, and constructively is counted If each unrelated shareholder owned 1/5, or 20%, of the foreign corporation, each of the shareholders would be U.S shareholders and the corporation would be a CFC The U.S persons not need to be related in order for the foreign corporation to be considered a CFC p 9-22 and Example 17 13 • If Joanna’s son becomes a 15% shareholder, is he a U.S shareholder subject to the Subpart F provisions? • Will Fred’s ownership be attributed to Joanna, causing her to be classified as a U.S shareholder subject to the Subpart F provisions? • Will Fred’s stock acquisition cause Axel’s resale of goods received from him to be foreign base company sales income? Will the Đ 1248 provisions apply to Joanna’s gain on the sale of her stock? pp 9-21 to 9-26 14 No Each of the U.S citizens owns one percent of the foreign corporation Consequently, none of the U.S citizens meets the definition of a “U.S Shareholder” (which requires 10% ownership) p 9-22 and Example 17 15 The “U.S Tax” limitation restricts the effects of the foreign tax credit in mitigating double taxation of foreign-source income The limitation prevents domestic corporations operating in high-tax foreign jurisdictions from offsetting those higher foreign taxes against the U.S tax on U.S.-source income p 9-28 and Example 27 16 Concerning foreign taxes paid by a U.S person, a deduction is claimed in computing U.S taxable income Alternatively, the taxpayer can claim a credit for those taxes against its U.S tax liability The same dollar of foreign tax paid can be used for either a deduction or a credit, but not both p 9-27 17 $14,000 The § 902 indirect foreign tax credit is added to the dividend amount in determining the gross income under § 78 The § 78 gross up is required in order to place the dividend © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 9-12 2012 Corporations Volume/Solutions Manual This approach to taxation is called a territorial approach, with a government taxing only the income earned within its borders The U.S taxation of foreign persons earning U.S investment or business income is referred to as “inbound” taxation p 9-3 and Figure 9.1 23 SPEECH OUTLINE A If a U.S taxpayer is subject to U.S income tax on profits earned outside the United States, and such profits also are subject to income tax in the foreign jurisdiction, the taxpayer escapes double taxation with the use of the foreign tax credit and/or deduction B Although the United States requires the U.S taxpayer to include all worldwide income from whatever source derived in its gross income, the U.S tax liability may be reduced by the foreign income tax paid or accrued by the U.S taxpayer C The taxpayer may be limited on how much foreign tax credit is allowed based on the foreign tax credit limitation formula, but in general the existence of the credit mitigates or eliminates double taxation pp 9-3, 9-6, 9-26 to 9-27, and Figure 9.1 PROBLEMS 24 RedCo will not incur any U.S income tax on GreenCo’s earnings GreenCo is a separate foreign corporation, made no dividend distribution to RedCo, and did not create any deemed dividend under Subpart F Consequently, RedCo has no current income related to its ownership of GreenCo pp 9-15, 9-19 to 9-21, and 9-23 25 a $3,000 U.S.-source Dividends from a domestic corporation generally are U.S.-source p 9-6 and Example b $6,000 U.S.-source Dividends from a domestic corporation generally are U.S.-source income The foreign business exception does not apply to dividends from a U.S corporation p 9-6 and Example c $1,000 U.S.-source Dividends from a foreign corporation may be U.S.-source if the payor earns significant (> 25%) U.S.-source income based on a look-through approach [i.e., $2,000 ì ($3,000,000 ữ $6,000,000)] p 9-6 and Example d The $600 is U.S.-source income because it is received from a domestic bank p 9-6 e $5,000 foreign-source Warren Corporation is a domestic corporation that meets the 80% foreign business requirement Of its gross income for the immediately preceding three-year period, 83.3% ($6,000,000 ÷ $7,200,000) was from the active conduct of a foreign trade or business p 9-6 and Example 26 Hoffman, Raabe, Smith, and Maloney, CPAs 5191 Natorp Boulevard Mason, OH 45040 November 3, 2011 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Taxation of International Transactions 9-13 Gloria Wang Av Rio Branco 149-4# Rio de Janeiro, RJ 22421 Brazil Dear Gloria: Your participation in the seven tournaments in the United States will result in $200,000 of U.S.-source income You are liable for U.S income taxation on this amount, but not on any of the $300,000 that you earned outside of the U.S The general rule is that income from services is sourced where the services are performed Physical performance, such as playing golf in a tournament, is categorized as personal services performed by an athlete Where the funds are deposited is irrelevant for sourcing purposes There is a ‘‘commercial traveler’’ exception available if all of the following requirements are met • The services must be performed by a nonresident alien who is in the United States for 90 days or less during the taxable year; • The compensation may not exceed $3,000 in total for the services performed in the United States; and • The services must be performed on behalf of: • a nonresident alien, foreign partnership, or foreign corporation that is not engaged in a U.S trade or business, or • an office or place of business maintained in a foreign country or possession of the United States by an individual who is a citizen or resident of the United States, a domestic partnership, or a domestic corporation The ‘‘commercial traveler” exception does not apply to you this year You are not in the United States for more than 90 days during the tax year, but the income attributable to your services performed in the United States exceeds $3,000 Furthermore, you are not performing in the capacity of an employee Thus, you are subject to U.S taxation on the $200,000 from your U.S tournaments Some income tax treaties allow a greater amount in making the ‘‘commercial traveler” test and some provide an exception for professional athletes as long as the earnings not exceed a certain amount specified in the treaty Sincerely, Tomas Suarez Tax Consultant p 9-7 and Example 27 a The gain is foreign-source income Gain from the sale of personal property is generally sourced at the residence of the seller, in this case an NRA An exception to this rule provides that the gain on sale of stock is taxable if the gain is attributable to an office or other fixed place of business that the NRA maintains in the United States © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 9-14 2012 Corporations Volume/Solutions Manual Use of a broker in the United States does not constitute a U.S trade or business pp 9-7 and 9-8 28 b Same as a Gain is foreign-source because seller is NRA, and sourced based on residency of seller pp 9-7 and 9-8 c The source of income from the sale of inventory manufactured in the United States and sold in another country is determined by allocating a portion of the income to the manufacturing activity and a portion to the sales activity The sales activity portion is generally sourced based on where title passes In this case, half the income is sourced in the United States (based on manufacturing) and half is sourced as foreign based on title passage § 863(b) and p 9-8 d Same as c Manufacturing income is foreign-source and sales income is U.S.-source (assuming title passes in the United States) p 9-8 a The royalty income is foreign-source Income from the use of intangible property is sourced according to where the intangible property is used p 9-8 b $45,000, the portion attributable to Marion’s days in the United States is U.S.-source (i.e., $150,000 × 75 days/250 days) Even though Marion is a nonresident alien, is not in the United States for more than 90 days during the tax year, and the services are performed as an employee of a foreign corporation that does not have a U.S trade or business, the amount attributable to U.S days exceeds $3,000 Thus, the commercial traveler exception does not apply p 9-7 and Example c The income is U.S.-source Gains on the disposition of real property located in the United States are U.S.-source income A building located in Denver is a U.S real property interest pp 9-8 and 9-37 d Seventy-seven thousand dollars ($77,000) of the gain is attributable to the depreciation adjustment Of the $105,000 gain, $77,000 is foreign-source income attributable to depreciation taken against foreign-source income, and the remaining $28,000 is sourced as gain on the sale of inventory (i.e., where title passes) Thus, $28,000 of the gain is U.S.-source income p 9-8 29 Foreign source p 9-8 30 Foreign source Royalties are sourced based on where the property is used p 9-8 31 $20,000 [$100,000 interest expense × $20 million/($80 million + $20 million)] p 9-10 and Example 32 a Interest expense is allocated and apportioned based on location of assets Assets producing foreign-source income Assets producing U.S.-source income Book Value FMV $5,000,000 $15,000,000 200,000 50,000 Tax Book Value Method: $300,000 (expense) × $5,000,000/$5,200,000 = $288,462 (foreign-source interest expense) FMV Method: $300,000 × $15,000,000/$15,050,000 = $299,003 (foreign-source interest expense) © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Taxation of International Transactions b 9-15 To minimize the amount of interest allocated against foreign-source income (the answer that maximizes the FTC in most cases), Energy should use the Book Value method p 9-10 and Example 33 No foreign currency exchange gain or loss is recognized until the payment is made Thus, no gain or loss is recognized in 2011 The cost of $500,000 (Ơ75,000,000 ữ Ơ150) is recorded for the equipment If payment is made when the foreign exchange rate is ¥250:$1US, the foreign exchange gain then recognized in 2012 is $200,000 ($500,000 – $300,000*) Weight pays only $300,000 for the ¥75,000,000 needed to make payment * Ơ75,000,000 ữ Ơ250 pp 9-13, 9-14, Example 11, and Concept Summary 9.1 34 January 6, 2011 Karen Burns Tax Director Table Inc Hometown, New Mexico Dear Ms Burns, Thank you for asking me to address your issues as to qualified business units (QBUs) in determining any foreign currency gain or loss Table, Inc., has two foreign qualified business units (QBUs) A QBU is a separate unit of a taxpayer’s trade or business that generally constitutes all the income and expense activities of the separate unit The manufacturing branch in Mexico is one QBU and the sales branch in Canada is a separate QBU Please let me know if I can be of any further help Sydney Jenkins Tax Manager Jenkins and Jarvis, CPAs pp 9-14 and 9-15 35 Chair should use the British pound as its functional currency for the Irish branch The functional currency of a QBU is the currency of the economic environment in which it operates Although the branch is located in Ireland, its economic environment is the U.K because it primarily earns revenue and pays expenses in British pounds p 9-14 36 Harold has only one QBU (the rare book business) and its functional currency is the Canadian dollar An individual is not a QBU although a trade or business conducted by an individual may be a QBU pp 9-14 and 9-15 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 9-16 37 2012 Corporations Volume/Solutions Manual TAX FILE MEMORANDUM Date: November 16, 2011 To: Margaret Zhang, Carroll Manufacturing Controller From: Ed Wood, Tax Consultant Subject: Foreign currency exchange and branch operations Because of the operation of an unincorporated branch in Ireland, Carroll Manufacturing incurs an Irish income tax liability Additionally, the branch income is translated from euros into U.S dollars and included currently in Carroll Manufacturing’s U.S taxable income The average exchange rate for the year will be used to convert the profits from euros to dollars Carroll Manufacturing does not recognize any foreign currency gain or loss until the branch’s profits are actually repatriated from Ireland At this time, the current dollar value of the profits repatriated will be determined by translating the distribution using the spot rate on the date of distribution This amount is compared with the dollar basis in these profits (i.e., the dollar amount of the branch’s profits that were previously included in Carroll’s U.S taxable income) Any difference in these amounts constitutes a foreign currency gain or loss pp 9-13 to 9-16 and 9-35 38 Red’s dividend income in U.S dollars is $11,111 (i.e., 10,000K ÷ 9) The dividend is translated at the exchange rate on the date of payment; thus, there is no exchange gain or loss If Red retains the foreign currency (which is now property with a basis of $11,111) and disposes of it at a later date when the exchange rate has changed, Red would have an exchange gain or loss on disposition of the foreign currency This, however, does not affect the amount of dividend included in gross income The separate transaction doctrine applies Because Red is a less-than-10% shareholder of Teal, it cannot claim any deemed-paid taxes Red can claim an FTC for any foreign taxes withheld on the dividend pp 9-13 to 9-16, 9-22, 9-28, and Concept Summary 9.1 39 Export profits of a U.S person generally are subject to U.S income taxation Thus, Hometown is subject only to the Federal corporate income tax on the $1,000 profit Usually, the country to which the goods are shipped does not tax such profit of the seller, when there are no assets or employees in that country p 9-16 40 No, this is the sort of transaction to which § 367 would apply It may ultimately be eligible for tax deferral depending on the application of § 367 pp 9-18, 9-19, and Example 14 41 Inventory gain is $30 Inventory is a tainted asset under § 367(a)(3)(B) Machinery gain is $35 Although machinery could qualify for the active trade or business exception under § 367(a)(3)(A), Buckeye must recapture $30 depreciation on property that was used in the U.S (not to exceed the amount of the asset’s realized gain) [Reg § 1.367(a)-4T(b)] for the patent pp 9-18, 9-19, and Example 14 42 When assets are transferred by a U.S person (WorldCo) to a foreign corporation, income or gain must be recognized to the extent it is present in tainted assets In effect, a deemed sale is treated as having occurred Inventory is a tainted asset Thus, WorldCo recognizes gross income on the transfer of the inventory if it is appreciated in value, when it incorporates the © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Taxation of International Transactions 9-17 foreign branch by transferring the assets to a newly-formed foreign corporation pp 9-17, 9-18, and Example 14 43 TAX FILE MEMORANDUM Date: November 4, 2011 To: Claire Quinty, Beach Inc., CFO From: Lisa Dahill Subject: Incorporation of Mexico branch Incorporation of a foreign branch falls under the provisions of § 367 First, the § 351 rules would normally treat the incorporation of a branch as a tax deferred event with basis carryover However, because the assets are leaving the U.S taxing jurisdiction, § 367 overrides § 351 and causes this incorporation to be a taxable event However, because the assets are being transferred to a foreign corporation to be used in a trade or business outside the United States, § 367 contains an exception that allows certain assets to be transferred with no current tax (i.e., basis carryover and any gain/loss is deferred) Assets that not qualify for this trade or business exception include inventory, accounts receivable, foreign currency, and certain leased property Additionally, depreciation recapture related to the use of the property in the United States is subject to immediate taxation upon transfer Accordingly, the taxation of the incorporation of the Mexican branch depends on the nature of the assets transferred Other than the tainted assets mentioned above, the branch assets can be transferred to the Mexican corporation with no current taxation Note that the depreciation should not be a problem as the depreciation was based on use outside the United States Furthermore, the prior branch losses will not trigger gain recognition as these losses have been offset with subsequent profits Finally, the incorporation of the branch at this time is a potentially good planning technique as future profits of the Mexican subsidiary will not be subject to tax in the United States until actually repatriated (unless the subsidiary earns Subpart F income) pp 9-16 to 9-19 44 Both LandCo and OceanCo are CFCs p 9-22 and Example 17 45 OK’s Subpart F income for the current year (before any expenses) is $750,000, made up of $600,000 in foreign base company sales income, $100,000 in foreign base company services income, and $50,000 in foreign personal holding company income a Because the sales are to customers outside Ireland, this income constitutes foreign base company sales income This is true because the inventory was manufactured outside Ireland and acquired from a related party b Even though the products are purchased from Hart (a related party), they are sold to customers in Ireland; thus, this $1,000,000 in income does not constitute foreign base company sales income © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 9-18 46 2012 Corporations Volume/Solutions Manual c None of this income is Subpart F income because there is no related party on at least one side of the transaction In this case, location of the manufacturing and customer is not relevant d OK is considered the manufacturer of this inventory Accordingly, this income is not Subpart F income, regardless of where the customers are located e Because OK earned $120,000 for the performance of warranty services on behalf of a related person (Hart), and these services were performed outside Ireland, this $100,000 is foreign base company services income f This $50,000 in dividend income represents foreign personal holding company income and will constitute Subpart F income pp 9-21 to 9-26 $263,014 [$1,000,000 × 80% ì (120 days ữ 365 days)] Round must include a portion of Square’s Subpart F income in gross income as a constructive dividend because Round was a shareholder of Square on the last day of the year in which Square was a CFC, and current E & P is not less than Subpart F income pp 9-21, 9-22, and Examples 15 and 16 47 Hoffman, Raabe, Smith, and Maloney, CPAs 5191 Natorp Boulevard Mason, OH 45040 November 9, 2011 Dear Mary Beth: You asked me to address the U.S tax consequences of placing your investments inside a Cayman Island corporation It appears on the surface that this approach has allowed you to reduce your overall tax liability because the Cayman Island corporation is now earning the investment income and it is not subject to U.S taxation However, Congress anticipated these type arrangements and enacted the Passive Foreign Investment Company (PFIC) rules to tax U.S individuals that hold their investments in such foreign corporations Because the foreign corporation’s primary source of income is passive, your share of the foreign corporation’s income will be either included in your U.S tax return and subject to immediate U.S taxation or subject to a special PFIC tax calculation Because this structure is not achieving your goal of U.S tax reduction, you should consider unwinding the foreign corporation in order to avoid the administrative costs of operating the Cayman corporation Please contact me if I can be of any further assistance Yours Truly, Harold Bloom pp 9-24 to 9-26 48 The FTC is the lesser of the actual foreign taxes, $228,000, or the statutory limit of $204,000 as determined under the general limitation formula ($1,500,000 × 34% = $510,000) × $600,000 $1,500,000 = $204,000 In this case, the statutory limit applies p 9-28 and Example 27 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Taxation of International Transactions 49 U.S taxable income Allowed FTC* Net U.S tax liability 9-19 $600,000 × 34% $204,000 (33,800) $170,200 *All $110,000 of foreign-source income is in the general limitation basket The FTC limit is $37,400 ($110,000/$600,000 × $204,000) Because the actual foreign taxes are less than the FTC limit, the entire $33,800 is allowed as a credit p 9-28 and Example 27 50 U.S taxable income Allowed FTC* Net U.S tax liability $500,000 × 34% $170,000 (20,000) $150,000 *The manufacturing branch produces general limitation income The FTC limit for this basket is $17,000 ($50,000/$500,000 × $170,000) Because the actual tax of $25,000 is greater than the limit, Pie will be allowed only $17,000 The interest income from Dutch bonds is passive basket income The limit is $6,800 ($20,000/$500,000 × $170,000) Because the actual tax in the passive basket is only $3,000, Pie is not limited and may use the entire $3,000 In summary, Pie is allowed a $20,000 FTC and has an $8,000 carryforward or carryback in the general limitation basket pp 9-28 to 9-30 and Example 29 51 ABC may claim a credit of $5 million, which represents the lesser of the $5 million of creditable foreign taxes and the foreign tax credit limitation of $5.25 million [($50 total taxable income × 35%) × ($15 million foreign source taxable income/$50 million total taxable income)] p 9-28 and Example 27 52 A domestic corporation can claim a deemed paid foreign tax credit if it owns 10% or more of the voting stock of a foreign corporation from which it receives a dividend However, U.S citizens and resident aliens are not eligible to claim a deemed paid credit Mary may not claim a deemed paid foreign tax credit p 9-28 53 ABC’s deemed paid taxes are $5 million ($50 million × [$5 million ÷ $50 million]), and its withholding taxes are $250,000 ($5 million × 5%) Therefore, ABC’s precredit U.S tax is $3.5 million ($10 million × 35%), the limitation is $3.5 million [$3.5 million ì ($10 million ữ $10 million)], and ABC has excess credits of $1.75 million [($5 million + $250,000) – $3.5 million] pp 9-27, 9-28, and Example 26 54 $187,500 [($300,000 dividend/$16,000,000 E & P) × $10,000,000 foreign income tax pool] pp 9-27, 9-28, and Example 26 55 $20,000 [($100,000/$1,000,000) × $200,000] pp 9-27, 9-28, and Example 26 56 Plane is allowed a zero FTC for the current year Although Plane paid foreign taxes in the passive basket, it recorded an overall foreign loss for the year ($200,000 loss less $50,000 income) The $5,000 in foreign income taxes in the passive basket may be carried back or forward pp 9-30, 9-31, and Examples 30 and 31 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 9-20 57 2012 Corporations Volume/Solutions Manual The deemed-paid foreign tax credit related to the dividend paid by Correy to Elmwood is $15,000 ($30,000 dividend/$400,000 post-86 E & P × $200,000 foreign income tax pool) The $30,000 dividend is ‘‘grossed up’’ under § 78 by the deemed-paid credit of $15,000, resulting in an inclusion in Elmwood’s U.S taxable income of $45,000 Elmwood’s resulting taxable income is $245,000 ($200,000 in other income and $45,000 related to the dividend from Correy) Elmwood’s U.S tax liability before the FTC is $83,300 ($245,000 × 34%) The allowed FTC is the lesser of (1) $15,000 (the foreign taxes deemed paid) or (2) $15,300 (the FTC limit of $83,300 × $45,000/$245,000) Accordingly, Elmwood is allowed the entire $15,000 of foreign taxes deemed paid as an FTC Elmwood’s total U.S tax liability is $68,300 ($83,300 − $15,000) pp 9-28, 9-29, and Examples 26 and 27 58 TAX FILE MEMORANDUM Date: November 3, 2011 To: Sally, CFO Chips, Inc From: John Heilman Subject: Overall Foreign Losses and the FTC Chips has generated net losses from its foreign operations in Singapore in the amount of $80,000 This year, the foreign operation began producing profits Ordinarily, these positive profits from foreign operations would result in the availability of an FTC for any foreign taxes paid to Singapore Any foreign-source income increases the FTC limitation calculation However, because the foreign operation has reduced U.S.-source income in the past through the deduction of losses, any subsequent profits must be recharacterized as U.S.-source to the extent of prior overall foreign losses This provision prevents the taxpayer from receiving a double benefit from the foreign losses (once from the offset against U.S income and second, from the increase in the FTC limitation formula from subsequent foreign profits) At the taxpayer’s election, the $80,000 of overall foreign losses is recharacterized as U.S.source over a period of time, with not more than 50% of current year foreign-source income being recharacterized as U.S.-source in any given year until the $80,000 is completely recharacterized pp 9-30, 9-31, and Example 30 59 Because Skills, Inc., has a loss in its general limitation basket, it must offset the income in the passive basket with this loss before determining the FTC limit in the passive basket Accordingly, the numerator of the passive basket limitation formula is $20,000 ($50,000 income offset by the $30,000 loss from the general basket) This reduction in the passive basket numerator reduces the passive basket FTC limit However, if the actual foreign taxes in the passive basket are still below the new, lower limit, there is no actual effect on the amount of allowed foreign tax credits within the passive basket pp 9-30, 9-31, and Examples 30 and 31 60 Canteen, Inc., includes $13,000 gross income in its U.S tax return as a result of receiving the dividend Although the dividend is only $8,000 in cash, the actual gross dividend is $10,000 (the withholding tax is not subtracted in determining the gross dividend) Under § 78, Canteen must “gross up” the dividend to include the amount of the § 902 credit Consequently, the © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Taxation of International Transactions 9-21 gross income is the $13,000 ($10,000 gross dividend plus $3,000 § 902 credit), assuming that Canteen desires to claim a foreign tax credit for the § 902 amount Note that Canteen holds a potential FTC of $5,000 subject to any limitation that applies ($2,000 § 903 direct credit plus $3,000 § 902 indirect credit) pp 9-27, 9-28, and Examples 25 and 26 61 a Interest income from a 5% owned foreign corporation does not trigger a deemed-paid FTC because such credits are only available with regard to dividend payments b Same as a Interest income does not generate a deemed-paid FTC at any level of ownership c No deemed-paid FTC is generated by this dividend The U.S corporation must own at least 10% of the foreign corporation directly in order to qualify for the deemed-paid FTC d A deemed-paid FTC is allowed for this dividend because the 10% ownership test is met pp 9-27 and 9-28 62 Night can earn up to $75,000 in foreign sales income without generating any excess foreign tax credits Foreign sales income and manufacturing income fall into the same FTC limitation basket Because the $300,000 is taxed at a foreign rate of only 30%, this income generates a $12,000 excess limit [the limit is $102,000 ($300,000 × 34), and the actual tax is $90,000] The $75,000 of foreign sales income ($12,000 excess limit ÷ 16 foreign tax rate exceeding U.S rate) is taxed at a 50% rate, producing foreign taxes of $37,500 Blending the two sources of income (one high-tax and one low-tax) results in using Night’s excess limit Combined, Night has $375,000 in foreign-source income and $127,500 ($90,000 + $37,500) in foreign income taxes The U.S tax on this $375,000 is $127,500, all of which is offset by the $127,500 allowed FTC pp 9-29, 9-30, and Example 29 63 The deemed-paid taxes are $52,632 (50,000 € ÷.95) The entire amount of $52,632 is an indirect foreign tax credit because the entire amount of E & P is distributed (150,000 ữ 150,000 ì $52,632) The foreign taxes are translated at the average exchange rate for the year to which the taxes relate The exchange rate on the dividend payment date is irrelevant for this purpose pp 9-15, 9-16, 9-27, 9-28, and Examples 13 and 26 64 Collins earned net foreign-source income for the year of $500,000 Collins incurred a loss of $300,000 in the general limitation basket and profits of $800,000 in the passive income basket Before calculating the FTC limit for each basket, the loss in the general basket must be allocated to the profits in any other baskets In this case, the entire $300,000 loss is allocated against the passive basket This results in $500,000 in foreign-source taxable income in the passive basket and $0 in foreign-source taxable income in the general basket • Collins has no foreign taxes related to the general limitation basket (and would be limited to $0 in any case because of the $0 foreign-source taxable income related to this basket) © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 9-22 2012 Corporations Volume/Solutions Manual • For the passive income basket, Collins is allowed an FTC equal to the lesser of (1) $64,000 in foreign taxes actually paid or (2) $170,000 FTC limit ($500,000 × 34%) Consequently, Collins is allowed a $64,000 FTC for the current year Collins is not limited despite the requirement to absorb the general basket loss pp 9-28, 9-30, 9-31, and Examples 27 and 30 65 Suggested outline I Transfer of property to a foreign corporation A Tangible property Generally tax free if used in a trade or business outside the United States B II Gain recognition on transfer of certain assets a Inventory b Installment obligations and accounts receivable c Foreign currency or other property denominated in foreign currency d Certain leased property e U.S depreciation Transfer of intangible property Sale for contingent payments Ordinary income (usually foreign-source) Received over life of the intangible (not to exceed 20 years) CFC status A B Definitions CFC U.S shareholder Tax effect Constructive dividend a Increase in investment in U.S property b Subpart F income (1) Foreign personal holding company income © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Taxation of International Transactions C III (2) Foreign base company sales income (3) Foreign base company services income (4) Foreign base company shipping income (5) Foreign base company oil-related income 9-23 Previously taxed income not taxed again when distributed Disposition of CFC stock Foreign tax credit A Direct credit B Deemed-paid foreign taxes C Separate basket limitations D Carryback and carryforward of excess foreign taxes IV Section 482 considerations V Reporting requirements pp 9-13 to 9-32 66 TAX FILE MEMORANDUM Date: November 4, 2011 To: Money, Inc From: Mike Caldwell Subject: Foreign investment alternatives It would be more profitable for Money, Inc., to invest in the stock of Exco The following analysis shows that the stock investment would yield a 6% return, while the bond investment would yield a 4.62% return The difference in returns probably reflect a ‘‘risk premium” involved in investing in the stock instead of the bonds Stock investment Gross dividend income = $30,000 ($3 × 10,000 shares) per year Deemed-paid foreign taxes = $22,222 [$4,000,000 ì ($30,000 ữ $5,400,000*)] Gross up dividend income to $52,222 ($30,000 + $22,222) U.S tax before FTC = $17,755 ($52,222 × 34) FTC = $17,755 (lesser of $22,222 or U.S tax) Net U.S tax = zero Total tax actually paid by Money on dividend = zero Net return = $30,000, or 6% ($30,000/$500,000) © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 9-24 2012 Corporations Volume/Solutions Manual In addition, if excess foreign taxes were incurred within the next years, $4,467 of excess FTC limitation is available for a carryback of the foreign taxes *The $5,400,000 E & P after taxes is determined by taking $9,400,000 minus $4,000,000 taxes (i.e., $10,000,000 × 40% tax rate) Bond investment Gross interest income = $35,000 ($500,000 × 7%) Foreign tax withheld = $8,750 ($35,000 × 25) No deemed-paid taxes are allowed on interest income U.S taxable income from interest = $35,000 U.S tax before FTC = $11,900 ($35,000 × 34) FTC = $8,750 (lesser of $8,750 or U.S tax) Net U.S tax = $3,150 Total tax actually paid by Money on interest income = $11,900 Net return = $23,100 ($35,000 – $11,900), or 4.62% ($23,100/$500,000 = 4.62%) The U.S taxes on the gross interest income are not as great as the U.S taxes on the grossedup dividend income However, a greater FTC is allowed for the taxes on the dividend income, since the deemed-paid taxes increase the amount of foreign taxes paid or treated as paid by Money pp 9-26 to 9-32 67 The taxable income from the U.S sales is U.S.-source income taxable at § 11 rates In addition, the interest on certificate of deposit is U.S.-source income and is not exempt from U.S taxation because the funds on deposit are effectively connected with the U.S trade or business (working capital) The security trading and resultant capital gains are foreign-source income because this activity is attributed to the home office, and the residence of the seller rule applies These items are tax free in the United States The dividends, however, are U.S.source income subject to withholding since the payors are U.S corporations IrishCo’s U.S income tax liability would be computed as follows Taxable income from U.S sales Interest income effectively connected with U.S trade or business Effectively connected income taxed at § 11 rates Tax on effectively connected income (34%) 15% tax withheld on dividends of $50,000 Total U.S tax liability $12,000,000 150,000 $12,150,000 $4,131,000 7,500 $4,138,500 pp 9-4, 9-5, 9-35, and 9-36 68 Vanguard has no effectively connected income (ECI) To have ECI, the foreign person must have a U.S trade or business Vanguard has no U.S trade or business Merely earning U.S.source income does not create a trade or business presence in the United States pp 9-35, 9-36, and Example 34 69 Clario has $1,009,000 in effectively connected income (ECI) The antique toy business creates a U.S trade or business Because Clario is engaged in a U.S trade or business, all of its U.S.-source income (other than FDAP income) is treated as ECI The fact that the toy business is unrelated to the furniture business is not relevant pp 9-34, 9-35, and Example 34 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Taxation of International Transactions 9-25 70 The interest earned on the CDs is U.S.-source income, but is not effectively connected to Palm’s U.S trade or business The CDs are not held for use in the U.S business, nor the activities of the U.S business generate the interest income Palm could just as easily repatriate the profits to its home office and invest directly in the CDs from there If the funds invested in CDs are working capital for the U.S branch and only temporarily invested in the CDs, the interest would be ECI pp 9-35, 9-36, and Example 35 71 TAX FILE MEMORANDUM Date: November 4, 2011 To: From: Tax VP, Trace Liang Fu Subject: Branch Profits Tax In addition to regular U.S income tax on any branch earnings, Trace incurs a Branch Profits Tax (BPT) liability of 30% of any dividend equivalent amount (DEA) The DEA is determined as follows Current year U.S effectively connected E & P Less: Increase in U.S net equity DEA $650,000 (400,000) $250,000 The BPT liability is $75,000 (30% of the $250,000 DEA) Several methods exist for reducing Trace’s BPT liability for the year First, Trace should consider increasing its U.S net equity by $250,000 (thereby reducing the DEA amount to zero) It could reduce distributions to the home office or increase reinvestment of profits in the United States Second, Trace might consider restructuring its operations so that the branch is operated by a foreign corporation in a country which has a treaty with the United States that reduces the BPT rate from 30% Third, Trace might consider incorporating its U.S branch as a U.S subsidiary This last choice should be evaluated carefully, as additional tax costs could arise as a result of the incorporation and operation of the U.S activity as a corporation rather than a branch p 9-36 and Example 36 72 Brenda would have no U.S tax consequences unless (1) the gain on the sale of the stock is effectively connected with a U.S trade or business or (2) treated as effectively connected with a U.S trade or business under § 897 In order for (2) to apply, Jeff, Inc must be a U.S real property interest (USRPI) Thus, it must be determined whether Jeff is a U.S real property holding company (USRPHC) Jeff’s U.S real property interests represent 84.4% of its total assets ($5,400,000 ÷ $6,400,000) This causes Jeff to be classified as a USRPHC and a USRPI Brenda would be taxed on the $5,900,000 gain realized on the sale of Jeff stock pp 9-37 and 9-38 73 If Jeff was a foreign corporation, § 897 would not cause the gain on the sale of the stock to be treated as effectively connected with a U.S trade or business Thus, the gain would not be taxable under § 897 However, if Jeff itself was to dispose of any U.S real property, such disposition would trigger taxation in the United States if any gains were recognized upon disposition pp 9-37 and 9-38 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 9-26 2012 Corporations Volume/Solutions Manual 74 Hoffman, Raabe, Smith, and Maloney, CPAs 5191 Natorp Boulevard Mason, OH 45040 November 8, 2011 Dear John, You have asked me to address the tax consequences of you giving up your U.S citizenship and moving to Bermuda where you will continue to operate your law practice via the Internet First, § 877 provides that you will be taxed in the United States on all of your U.S.-source income for 10 years following your abandonment of citizenship if it can be demonstrated that you gave up your citizenship to avoid U.S taxation This 10-year provision is likely to apply in your case Sections 6039G and 7701(n)(1) will require you to file certain information with the United States and § 877(g) may limit your ability to spend 30 days or more in the United States each year The question then becomes whether you will generate any U.S.-source income within this 10year window Operation of your law practice via the Internet may or may not create U.S.source income The taxation of Internet activities is very ambiguous under current law If the IRS considers the activity to be a provision of services, the place those services are provided will determine the source It is an open question as to whether those services are provided at your end of the computer (Bermuda) or at the client’s end of the computer (the United States) If your legal services take the form of some sort of packaged product that is sold within the United States via the Internet, the sourcing rules are likely to treat this income as U.S.-source income based on the passage of title to this inventory within the United States Sincerely, Melissa Knechel pp 9-38 and 9-39 75 $150,000 (30% × $500,000) The withholding tax is on the gross amount of the dividend pp 9-34 and 9-35 76 $60,000 (30% × $200,000) The withholding tax is on the gross amount of the dividend pp 9-34 and 9-35 77 $80,000 (10% × $800,000) The withholding tax (reduced by treaty) is on the gross amount of the dividend pp 9-19, 9-20, 9-34, 9-35, and Exhibit 9.2 The answers to the Research Problems and the Tax Return Problems are incorporated into the Instructor’s Guide with Lecture Notes to accompany the 2012 Annual Edition of SOUTH-WESTERN FEDERAL TAXATION: CORPORATIONS, PARTNERSHIPS, ESTATES & TRUSTS © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part ... download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 9-26 2012 Corporations Volume/Solutions Manual 74 Hoffman, Raabe, Smith, and Maloney, CPAs 5191 Natorp... To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 9-16 37 2012 Corporations Volume/Solutions Manual TAX FILE MEMORANDUM Date: November 16, 2011 To:... ebook, solutions and test bank, visit http://downloadslide.blogspot.com 9-20 57 2012 Corporations Volume/Solutions Manual The deemed-paid foreign tax credit related to the dividend paid by Correy