United States Taxation of Foreign Investors

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  United States Taxation of foreign investors INTRODUCTION   The United States has long been a safe haven for foreign investors. Now it has becomenot only a safe haven for foreign investors, it has also become a nation that has myriadreal estate and business assets all available for acquisition at bargain prices due to theprecipitous fall in the U.S. dollar. What is not so well known is that the United States taxlaws are very favorable to foreign investment; providing at times for the payment of taxfree interest by U.S. taxpayers to foreign investors. Capital gains from investment maybe tax free or subject to tax rates of 15%, and the complex laws provide for numerousmethods of deferring the payment of U.S. taxes to a later point in time. At the sametime, these same laws can become tax traps for the poorly advised investor and cancause income taxes on profits to be as high as 65% and estate (inheritance) taxes to bepaid on U.S. assets held at death as high as 48%. The following narrative outline isintended to provide the foreign investor, both corporate and individual, with only a basicintroduction to the tax laws of the United States as they apply to that foreign investor.Hopefully, it will let the foreign investor know that they are welcome in the United States.More importantly, it should help the foreign investor know that the U.S. tax laws arecomplex and must be dealt with in a highly professional manner; if one is to avoid thetax traps and take advantage of the many tax benefits offered by the United States. Thegeneral principles discussed herein are not intended to be legal or tax advice andtaxpayers should consult with their individual legal, accounting, and tax advisors. U.S. Taxation of Foreign Investors Table of Contents   I . TAXAT IO N PATTERN   II . STATUS F O R TAX PURP O SES   III . TW O TYPES O F FEDERAL I NC O ME TAXAT IO N PATTERNS   IV . THE EFFECT O F B I LATERAL TREAT I ES   V . THE BRANCH PR O F I TS TAX   VI . PRE- I MM IG RAT IO N PLANN I N G ± I NC O ME TAX AND G  A I NS   VII . PRE- I MM IG RAT IO N PLANN I N G ± ESTATE AND GI FT TAX   VIII . EXCEPT IO NAL C I RCUMSTANCES AND SPEC I  AL TAX BENEF I TS   I X. REAL ESTATE - TAXAT IO N PATTERN   X. O WNERSH I P O F REAL PR O PERTY   X I . TAX PLANN I N G BENEF I TS AND TRAPS UN IQ UE T O THE F O RE IG N I N V EST O R I N REAL ESTATE    X II . THE TAX PLANN I N G STRUCTURES   I. TAXATION PATTERN   y   United States Resident Alien ( Tax Resident ) - Subject to Taxation   a.   I ncome Taxation - Worldwide I ncome b. Estate Taxation - Worldwide Assets c.   G ift Taxation - Worldwide Assets   y   Non Resident Alien - Subject to Taxation   a.   I ncome Taxation - United States Source I ncome, Limited type of Foreign Source I ncome b. Estate Tax - United States Situs Assets O nly c.   G ift Tax - Real and Tangible Personal Property with a United States Situs   There is a vast difference in the manner in which the United States will apply its income, estate and gifttaxes to a would-be immigrant that is considered a tax resident and one that still has non-residentalien status. A tax resident will be subject to U.S. incomes taxes, estate taxes and gift taxes on aworldwide basis. Non-resident aliens will generally only pay U.S. income tax on income earned from U.S.sources and will pay U.S. estate taxes only on real property and tangible personal property in the UnitedStates, and selected intangible assets.   II. STATUS FOR TAX PURPOSES   y   Resident for Income Tax Purposes   a. G reen Card b. Substantial Presence Test c. V oluntary Election d. The Closer Connection Exception e. Treaties: Tie Breaker    Nonresident Alien Individuals - Income Tax   A nonresident alien individual is defined as any citizen of a country other than the United States who isnot a U.S. resident for U.S. income tax purposes. The general rule is that an alien is not considered tobe a U.S. resident for tax purposes if the alien does not have (1) a green card representing permanentresidency in the U.S. or (2) a substantial presence or time period in the U.S. as described below. Thereare exceptions to this general rule that will also be discussed.    An alien individual has a substantial presence in the United States for the calendar year in which thealien is both physically present in the U.S. for at least 31 days and; in that same calendar year isconsidered to have been in the U.S. for a combined total of 183 days or more over the past three yearspursuant to a formula.   For purposes of calculating this combined 3 year, 183-day requirement; each day present in the UnitedStates during the current combined calendar year counts as a full day, each day in the preceding year as one-third of a day and each day in the second preceding year as one-sixth of a day. This is shown onthe example below.   The United States has tax treaties with many countries. These treaties generally provide that theresidents and corporations of each country to the treaty are entitled to a more liberal tax treatment thanresidents and corporations of non-treaty countries. The concept of residency under the treaties is different  than the general definition and may permit a nonresident alien to spend more time in the U.S. each year without being a U.S. tax resident. G enerally, the tax treaties will permit the alien individual to remain anon-resident for U.S. tax purposes so long as the alien covered by the treaty stays less than 183 days inthe U.S. each separate year: and not over the cumulative three year period.   This same type of treatment, that of permitting aliens to have an extended stay in the U.S. of less than183 days in each year without becoming a U.S. tax resident, is also available to certain aliens that are notfrom countries governed by a U.S. tax treaty. I f an alien has provable close business and social ties to hisor her native country; the substantial presence test is extended due to their closer connection to aforeign country than to the U.S.   Foreign Corporation - Income Tax   A foreign corporation is a recognized separate taxpayer for U.S. tax purposes. A foreign corporation for U.S. tax purposes, is a corporation that is not organized under the laws of the United States or any one of the states of the United States. A foreign corporation¶s articles of incorporation will reflect whether it is aforeign corporation or a U.S. domestic corporation.   III. TWO TYPES OF FEDERAL INCOME TAXATION PATTERNS   U.S. Taxpayers (Citizens and Resident Aliens)   As a general rule, U.S. domestic corporations and United States citizens and residents aretaxed by theU.S, on their worldwide net incomeregardless of the source of the income. Exceptions to this rule existonly to prevent double taxation of foreign income earned by U.S. individuals and Companies abroad.Double Taxation is prevented by allowing U.S. taxpayers to obtain a credit against their U.S. tax for foreign taxes paid on that same income.   Foreign Taxpayer    Foreign Taxpayers (both alien individuals and foreign corporations), however, pay U.S. tax on U.S.income in two entirely different ways depending upon whether the income the Foreign Taxpayer earns isfrom passive sources or whether the income results from the Foreign Taxpayer¶s conduct of an activetrade or business in the U.S. Furthermore, the U.S. tax rules for Foreign Taxpayers take into account the fact that the jurisdiction of theUnited States can extend just so far. Therefore, as a general rule a Foreign Taxpayer will only pay U.S.  tax on their U.S. Source I ncome and not on income earned from outside of the United States. There arehowever exceptions. I n order to understand the two different types of taxation, it is important to examine the general rules thatdefine whether a Foreign Taxpayer is conducting an active business in the U.S. or a passiveinvestment as well as the rules governing source of income and the source of deductions . Thesedefinitions determine which one of the two sets of tax rules must be applied in order to calculate the U.S.tax liability of foreign corporations and nonresident alien investors. y   Source of Income Rules   a. U.S. Source I ncome b. Foreign Source I ncome c. Deductions   There are a strict set of rules that govern the determination of whether income finds its source inthe United States or a foreign place for U.S. tax purposes. They are as follows:   1. Compensation for personal services. The source of income from the performance of personalservices is located at the place where the services are performed. 2 . Rents and royalties. Rent or royalty income has its source at the location, or place of use, of theleased or licensed property. 3. Real Property Income and Gain.   I ncome and gain from the rental or sale of real estate has its sourceat the place where the property is situated. 4. Sale of personal property. Historically, gain from the sale of personal property has been sourced atthe place of sale which is generally held to be the place where title to the goods passes; however therules have become more complex taking other factors in place. 5. Interest. The source of interest income is generally determined by reference to the residence of thedebtor; interest paid by a resident of the United States constitutes U.S. source income, while interest paidby foreign residents is generally foreign-source income. 6. Dividends. The source of dividend income generally depends on the nationality or place of incorporation of the corporate payor; that is, distributions by U.S. corporations constitute domestic-sourceincome, while dividends of foreign corporations are foreign-source income. There are, however, severalimportant exceptions to these rules. 7. Partially Within and Partially Without. There is a set of source rules that consider the sources of income that can be partially earned in the U.S. and partially from foreign sources such as income fromtransportation services rendered partly within and partly without the United States; income from the saleof inventory property produced , created , fabricated , manufactured , extracted , preserved , cured , or aged without and sold within the United States or vice versa, and several other types of income. G enerally, this is done on some type of allocation basis between the source countries.   Source of Deductions  The source rules for deductions are considerably less specific than those dealing with gross income. Therules regarding claiming deductions against U.S. income earned by a Foreign Taxpayer merely providethat taxable income from domestic or foreign sources is to be determined by properly apportioning or allocating expenses, losses, and other deductions to the items of gross income to which they relate.   y   Taxation of Passive (Non Business Income)   a. 30% Flat Tax Rate ± G ross I ncome b. Withholding obligations   y   The Taxation of Passive Income   I f the income that a Foreign Taxpayer earns is passive in nature and does not result from the
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