International applications of U.S. income tax law

International Applications

of U.S. Income

Tax Law

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International Applications

of U.S. Income

Tax Law

Inbound and

Outbound Transactions

ERNEST R. LARKINS

John Wiley & Sons, Inc.

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This book is printed on acid-free paper.

Copyright © 2004 by John Wiley & Sons, Inc. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey

Published simultaneously in Canada

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Library of Congress Cataloging-in-Publication Data:

Larkins, Ernest R. (Ernest Radford)

International applications of U.S. income tax law : inbound and outbound transactions /

by Ernest R. Larkins.

p. cm.

Includes index.

ISBN 0-471-46449-X (cloth : acid-free paper)

1. Income tax—United States—Foreign income. 2. Investments, Foreign—Taxation—

Law and legislation—United States. 3. Aliens—Taxation—Law and legislation—United

States. 4. Foreign tax credit—United States. 5. Double taxation—United States.

I. Title: International applications of US income tax law. II. Title.

KF6419.L37 2004

343.7305′248—dc21

2003014219

Printed in the United States of America

10 9 8 7 6 5 4 3 2 1

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My wife, Nancy, has acted as cheerleader (and unofficial press

agent) throughout the process. She has my appreciation for her

confidence and enthusiasm. I dedicate this text to the three people

I have enjoyed teaching the most—my own children—Joshua,

Esther, and Hannah. I also thank the many Georgia State

University students who have taken my international tax class,

and wish them well in their lives and careers.

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vii

As the purchaser of this book, International Applications of U.S. Income

Tax Law: Inbound and Outbound Transactions, you have access to the

supporting Web site:

www.wiley.com/go/internationaltax

The Web site contains a Word file for the “U.S. Model Income Tax

Treaty (September 20, 1996).”

The password to enter this site is: international.

About the Web Site

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ix

Preface xiii

PART ONE

Generic Topics 1

CHAPTER 1

Policy and Overview 3

International Tax Policy 3

Entity Selection 7

Generic Topics 10

Inbound Transactions 11

Outbound Transactions 12

Related Person Transactions 14

CHAPTER 2

Jurisdiction to Tax 16

Tale of Two Systems 16

U.S. Jurisdiction 20

Double Taxation 21

CHAPTER 3

Income Tax Treaties 23

Treaty Creation and Authority 24

Treaty Scope 27

Personal Service Income 30

Business Profit 33

Investment Income 40

Gain from Dispositions 45

Special Clauses 46

CHAPTER 4

Source of Income 49

Fundamental Importance 49

General Source Rules 50

Contents

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Interest Income 51

Dividend Income 55

Personal Service Income 59

Rent and Royalty Income 62

Gain from Selling Property 63

Other Source Rules 77

CHAPTER 5

Allocation and Apportionment 81

Allocation to Classes 82

Apportionment to Groupings 84

Interest Deductions 87

Research and Experimental Deductions 95

Other Deductions 102

PART TWO

Inbound Transactions 105

CHAPTER 6

Foreign Persons 107

Residency Tests 108

Counting Days 111

Dual Status Aliens 112

Important Elections 114

CHAPTER 7

Nonbusiness Income 119

Fixed or Determinable, Annual or Periodical Income 119

Marginal Tax Rates 122

Nonbusiness Exemptions 125

Interest Stripping 129

CHAPTER 8

Business Income 133

U.S. Trade or Business 134

Effectively Connected Income 139

Business Exemptions 147

Income Tax Calculations 147

x CONTENTS

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CHAPTER 9

Real Property Gains 150

U.S. Real Property Interests 151

U.S. Real Property Holding Corporations 155

Withholding Procedures 164

Structures for Holding U.S. Real Estate 165

CHAPTER 10

Branch Taxes 172

Branch Profits Tax 172

Marginal Tax Rates 177

Branch Interest Tax 179

PART THREE

Outbound Transactions 183

CHAPTER 11

Foreign Tax Credit 185

Creditable Taxes 188

Deemed Paid Taxes 204

Limitation Formula 212

Tax-Sparing Credit 238

CHAPTER 12

Controlled Foreign Corporations 241

CFCs and U.S. Shareholders 245

Subpart F Income 254

Earnings Invested in U.S. Property 277

Constructive Dividends 280

CHAPTER 13

Other Antideferral Provisions 285

Passive Foreign Investment Companies 285

Qualified Electing Funds 298

Foreign Personal Holding Companies 301

CHAPTER 14

Export Incentives 309

Extraterritorial Income Exclusion 311

Domestic International Sales Corporations 313

Contents xi

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CHAPTER 15

U.S. Individuals Abroad 327

Foreign Earned Income Exclusion 328

Income Sourced in U.S. Possessions 344

Social Security Concerns 346

PART FOUR

Related Person Transactions 349

CHAPTER 16

Transfer Prices 351

General Principles 354

Loan of Funds 358

Performance of Services 360

Rental of Tangible Property 362

Sale or License of Intangible Property 363

Sale of Tangible Property 371

Valuation Misstatements 376

Advance Pricing Agreements 378

CHAPTER 17

Asset Transfers 380

Outbound Asset Transfers 383

Inbound Asset Transfers 391

External Asset Transfers 393

Glossary 395

Table of Statutes 421

Table of Regulations 423

Table of Cases 425

Table of Rulings 427

Index 429

xii CONTENTS

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xiii

Globalization means that increasingly few tax professionals can avoid in￾ternational tax issues. The daily capital that flows into and out of the

United States exceeds $14 billion. Many of these flows involve tax issues.

Without an understanding of international tax issues, tax professionals can

easily overlook benefits or inadvertently stumble into tax pitfalls. Beyond

the legal text, professionals must consider the marginal tax rate applicable

to international transactions.

An extraordinarily broad topic, international taxation includes the

study of many countries’ tax laws and the international agreements among

those countries affecting tax liabilities. This book explores a less-ambitious

area: the international aspects of U.S. income tax law. Thus, the 17 chapters

focus on the U.S. income tax laws and international agreements affecting

cross-border transactions of both U.S. and foreign persons. The tax systems

of other nations receive attention only to illustrate overall tax concepts or

the application of U.S. law.

U.S. international taxation involves two major types of activities cross￾ing national borders: inbound and outbound transactions. Inbound transac￾tions occur when foreign persons conduct business in the United States or

make U.S. investments. Outbound transactions occur when U.S. persons

conduct business abroad or make foreign investments.

For both inbound and outbound transactions, knowledge of certain

“generic” topics is crucial. Thus, Part One explains topics applicable to both

inbound and outbound activities: tax policy objectives, jurisdiction, tax

treaties, source of income rules, and allocation and apportionment proce￾dures. Part Two discusses inbound transactions, including the determination

of residency status, U.S. taxation of foreign persons, meaning of effectively

connected income, U.S. tax consequences when foreign persons dispose of

U.S. real estate, and the U.S. branch profits tax. Some concepts involving the

taxation of foreign persons (e.g., effectively connected income) facilitate the

study of outbound transactions. Also, the statutory and regulatory law deal￾ing with inbound transactions is less voluminous and complex than the tax

law dealing with outbound transactions. For these reasons, outbound topics

follow inbound topics. Part Three covers the foreign tax credit, antideferral

rules, and incentives for exporting and working abroad. Finally, Part Four

deals with related person issues such as transfer pricing and international

Preface

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reorganizations. These rules may affect inbound and outbound transactions

but are not essential to the understanding of either. Thus, the text covers re￾lated person issues last.

The text contains many special features:

Empirical Evidence: Located primarily in footnotes, this feature refer￾ences studies linking tax law changes and the managerial reaction of

multinational companies.

Examples: Apply points of law discussed in the text. Many illustrate ap￾plication of U.S. provisions with examples based on foreign tax laws.

Exhibits: Assist readers in visualizing and understanding fundamental

provisions.

Flashbacks: Relate the current text to materials appearing earlier in the

book and, thus, assist the reader in synthesizing rules and concepts.

Important Terms: Appear in bold type within the text and are defined

in the glossary.

Key Cases: Summarize most important judicial opinions.

Marginal Tax Rate Analyses: Numerous equations and formulas facili￾tate the reader’s understanding and synthesis through focus on aggre￾gate economic effects of legal rules.

Pointers: Showcase compliance-related matters, planning ideas, research

materials, comparative tax systems, and cultural issues.

I hope this text whets the appetite of the international tax novice, and

provides practical guidance to those with international experience. To this

end, I invite and welcome all comments, suggestions, and corrections. The

reader can send correspondence to Ernest R. Larkins, P.O. Box 4050, School

of Accountancy, Georgia State University, Atlanta, GA 30303-4050 or to

[email protected].

xiv PREFACE

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