Northeastern University, D’Amore – McKim School of Business – taught by David Hardesty
This course explores in depth the U.S. taxation of foreign persons (including both entities and natural persons) that do business in, sell products to, or invest in the United States. In this course, students will learn about the classification of foreign persons as resident and nonresident aliens and domestic or foreign entities; taxation of non-business income, and the related rules for U.S. withholding on non-business income; taxation of business income under U.S. domestic tax law, and taxation of business income under U.S. tax treaties; sourcing of income as either domestic or foreign; allocation of deductions to U.S.-source and foreign-source income; the branch-level tax rules; and the special rules for the U.S. taxation of the disposition of U.S. real property interests.
Prerequisites: TA 318, Advanced Federal Income Taxation, and TA 329, Tax Research and Decision Making
Week 1: Classification of Foreign Persons and Aliens – The taxation of inbound transactions refers to the U.S. taxation of income earned by foreign persons, including nonresident alien individuals, and foreign corporations, trusts, and estates. The broad objective of this course is to give students a thorough grounding in the U.S. tax rules that impact foreign persons doing business in, selling products to, or investing in the United States.
In order to apply the rules for taxing foreign persons, we first must know whether a taxpayer is a foreign person. That is, we need to know of a person is classified as:
– A nonresident alien or a resident alien
– A foreign corporation or a U.S. domestic corporation
– A foreign trust, estate or partnership, or a U.S. domestic trust, estate, or partnership
Week 2: Non-Business Income and Withholding – Last week, we learned about the classification of foreign persons. Now we begin our study of the ways in which foreign persons are taxed, under U.S. tax law. In this week, we will study the taxation of non-business income, and we will study the withholding of U.S. income tax on nonbusiness income.
Our first topic this week is a big one: the U.S. taxation of non-business income. The types of non-business income that are of most concern are interest, dividends, rents, and royalties received from sources in the United States. As we will see foreign persons can be taxed in the United States on this type of income even if they never visit the United States. We will learn that some income that would otherwise be considered non-business income is actually classified as business income, when it is earned in connection with a U.S. business.
In addition to being taxable, non-business income earned by a foreign person is usually subject to income tax withholding. There are exemptions, of course. Some non-business income is exempt from U.S. tax and is also exempt from withholding. We will find, however, that to obtain such an exemption it is important that foreign persons file the right forms with institutions that make payments of non-business income. We will also find that some non-business income, though taxable in the United States, is not subject to withholding.
If exceptions do not apply, and non-business income is taxable, then it is also subject to withholding at source. This means that the payer must withhold tax on payments to foreign persons, and if the payer does not do so, the payer is personally liable for the tax.
Note that, through all of the topics studied in Week 2, we will return again and again to the impact of U.S. tax treaties. We will find, for example, while dividends received by a foreign person may be subject to tax in the United States at a 30% rate under U.S. domestic tax laws, the tax rate may be much less if a U.S. tax treaty applies, and for some countries, there may be no tax at all.
Obviously, this is an incredibly important set of rules, and we will spend some time on them. You will start by watching and/or reading the lectures for lessons one and two; you will next review the written lecture and do the reading indicated in that lecture; then take the quizzes for lessons one and two, participate in the Week 2 discussion problems.
Week 3: Taxation of Business Income — U.S. Domestic Tax Rules – Last week, we studied the U.S. taxation of non-business income. In this week, we study the taxation of business income under U.S. domestic tax law.
Unlike non-business income, the business income of nonresident aliens and foreign entities is taxed in the United States only when that income is effectively connected with the foreign person’s U.S. trade or business. Accordingly, we will first determine what is and what is not a U.S. trade or business; then we will learn when income is effectively connected with that U.S. trade or business.
Week 4: Taxation of Business Income – Tax Treaty Rule – Last week, we studied the U.S. taxation of business income and U.S. domestic tax rules. This week, we study the taxation of business income and U.S. tax treaties.
We will find that U.S. tax treaties can dramatically reduce and sometimes eliminate a foreign person’s U.S. tax liability on business income. Treaties do this by taxing only the income attributable to a permanent establishment in the United States. A permanent establishment is usually a fixed place of business, but it can also be created by a single person in the United States who has no fixed place of business but who has the power to make contracts on behalf of the foreign taxpayer. The permanent establishment rule is a great benefit to a foreign person who does business in the United States, and whose presence is sufficient to create a U.S. trade or business but is not sufficient to create a permanent establishment.
Week 5: U.S. Source vs. Foreign Source Income and Deductions – Over the last four weeks, we have worked through the vast array of rules for the taxation of U.S.-source nonbusiness and business income. All of this work begs the question, what is U.S.-source income? That is what we will learn this week when we study the basic rules for determining the source of income—and the companion rules for determining the deductions related to that income.
The source of income, as either U.S.-source or foreign-source, is the subject of Lesson 1. This is a large topic, and a major part of the Tax Code and related regulations. The importance of sourcing income is that, under U.S. domestic tax law, a foreign person is usually subject to U.S. tax only on U.S.-source income. This is the case even if a U.S. tax treaty applies, because a foreign person must first have U.S.-source income before there is a potential for tax.
The sourcing of income is a two-part analysis. First, we classify the income (we will learn the seven major categories into which income can be classified); then we apply the sourcing rules specific to each classification of income. Because there are seven categories of income, there are also seven different sets of rules for determining the source of that income.
Oddly, tax treaties do not have a lot of impact on the sourcing rules. As we learned in our study of the U.S. taxation of business income under tax treaties, U.S. tax treaties use a unique set of rules for determining income subject to tax. Instead of sourcing income, treaties attribute income to activities taking place in a permanent establishment. So in many ways, the sourcing rules have little impact when a tax treaty is involved.
In Lesson 2, we study the deductions. Because foreign persons are not allowed deductions against their U.S.-source nonbusiness income, the rules do not apply to nonbusiness income. For business income, however, we must determine the deductions allocable to U.S.-source effectively connected income. As we will see, there are general rules for allocating and apportioning deductions, and there are special rules. The special rules will take up most of our time.
Week 6: Branch Level Taxes – Over the last five weeks, we have studied many topics in the taxation of inbound transactions, and we have learned a lot about the taxation of business income. This week, we focus on branch-level taxes, which are additional U.S. taxes on business income that apply when a foreign corporation is engaged in a U.S. trade or business.
In Lesson 1, we study branch-level taxes. Under this tax, a foreign corporation with an unincorporated branch in the United States, which has already paid U.S. tax on the income earned by that branch, can pay an additional tax if it transfers assets out of the United States—such as by transferring cash back to the home office. This provision of U.S. tax law essentially treats the U.S. branch as a U.S. corporation, and then taxes the transfer of assets out of the country as a taxable dividend to the foreign corporate parent. At 30%, the tax is fairly significant. This is the same rate that would apply if a U.S. corporation paid a dividend to a foreign person, and no treaty is applied to reduce the tax. Speaking of tax treaties, we will find that U.S. tax treaties can reduce the branch profits tax, and we will learn when treaties apply.
Week 7: Dispositions of U.S. Real Property Interests –
Over the last six weeks, we have studied many topics in the taxation of inbound transactions and learned a lot—but we are not finished yet. We need to look at one more area of U.S. taxation before we can consider our work complete.
Lesson 1 concludes our entire course on inbound taxation with the study of U.S. taxation of the dispositions of U.S. real property interests. As we learned earlier in this course, nonresident aliens and foreign corporations are taxed on U.S.-source capital gains only under narrow circumstances. As an exception, they are commonly taxed on capital gains that result from dispositions of U.S. real property interests. Not only must foreign persons file U.S. tax returns and pay tax on these gains, the dispositions themselves are subject to withholding on sales proceeds.
What are U.S. real property interests? Not surprisingly, they are direct interests in real property located in the United States, but they also include stocks of U.S. corporations that invest heavily in real estate. We will study in detail the rules for determining when U.S. corporations are classified as U.S. real property interests.