Aliens Who Invest in the United States Through a Low-Tax Jurisdiction focuses on the planning techniques by which non-U.S. citizens (i.e., “aliens”) may lawfully minimize or eliminate U.S. federal transfer taxes (estate, gift, and generation-skipping transfer taxes) on their U.S. investments by making the investment through a so-called “tax haven” (low-tax, or tax-free foreign country). This is usually done by placing U.S.-situs assets in a non-U.S. holding company, although it may also be done instead by utilizing a trust or a partnership.
Written by Thomas St.G. Bissell, Esq., this Portfolio addresses the fact that although avoidance of U.S. transfer taxes is usually the alien investor's principal concern, there may be a number of U.S. federal income tax consequences to the manner in which the alien makes the investment, particularly if the alien becomes a U.S. resident for income tax purposes (chapters VIII and IX), or if the alien has U.S. heirs (chapter IV). The existence of U.S. heirs may also encourage the alien to utilize a so-called “dynasty trust” so as to avoid U.S. transfer tax on the U.S. heirs in later generations.
Aliens Who Invest in the United States Through a Low-Tax Jurisdiction explains fundamental concepts and terms, and also describes the characteristics of tax havens and the reasons for their frequent use in structuring U.S. investments. It briefly examines various initiatives on the part of certain international organizations aimed at eliminating perceived abuses in the use of tax havens by individuals resident in high-tax countries. This Portfolio then describes the U.S. transfer tax and income tax effects of various tax haven structures.
In addition, it discusses special types of U.S. investments, such as investment in U.S. real estate (chapter X), portfolio investments by aliens who might use a tax haven brokerage account maintained in their personal names and without any other structure, the use of offshore insurance products (this area includes a summary chart in the Worksheets), and the establishment in a tax haven of a charitable organization. This Portfolio also discusses issues that arise where an alien (including a former U.S. citizen subject to the U.S. anti-expatriation rules) has established tax residence in a tax haven country.
Aliens Who Invest in the United States Through a Low-Tax Jurisdiction allows you to benefit from:
This Portfolio is part of the Foreign Income Portfolios Library, a comprehensive series containing more than 90 Portfolios, which covers critical transactions and issues in international taxation. This highly-regarded resource service offers commentary on a wide range of foreign income topics including: Foreign Tax Credit, Business Operations in more than 40 foreign countries, Branch ProfitsTax, Source of Income Rules, Subpart F (Controlled Foreign Corporations), Foreign Partnerships and Partners, Transfer Pricing, and more.
Detailed Analysis
I. Introduction
Introductory Material
A. Categories of Foreign Individuals
B. Reasons for Investing in the United States Through a Tax Haven
1. U.S. Tax Reasons
2. Foreign Tax Reasons
a. NRNCs Who Are Not Subject to Foreign Taxes
b. NRNCs Who Comply with the Laws of a Country that Imposes Taxes
c. NRNCs Who Do Not Comply with their Country's Tax Laws
d. NRNC's Foreign Tax Status Usually Not Relevant for U.S. Tax Purposes
3. Non-tax Reasons
C. Classification of the Tax Haven Entity for U.S. Tax Purposes
D. Special Issues Concerning Trusts
1. Is the Trust "Domestic" or "Foreign"?
2. Private Trust Company Acts as Trustee
3. Trust "Protectors"
4. "Letter of Wishes"
5. Repeal of the Rule Against Perpetuities
6. "Abusive Trusts"
7. Asset Protection Trusts
E. Characteristics of a Tax Haven
F. Use of Tax Havens by U.S. Citizens and Residents
G. Pending Repeal of the Federal Estate Tax
H. Discussion of the Generation-Skipping Transfer Tax
I. Abbreviations and Terminology Used in this Portfolio
1. Abbreviations for Residence and Nonresidence
2. Abbreviations for U.S. Taxes: "FIT," "FET," "FGT," and "GST"
3. Other Abbreviations
4. "Foreign Holding Company," "Foreign Trust," and "Foreign Partnership"
J. Scope of this Portfolio
II. Anti-Tax Haven Initiatives by the Developed Countries
A. The OECD Initiative
B. The FATF Initiative
C. Other Reports and Initiatives
D. U.S. Anti-Terrorist Legislation
E. Potential Impact of the OECD Initiative on the Use of Tax Havens by NRNCs
III. Use of a Foreign Holding Company by a NRNC To Avoid FET
A. Introduction
1. Special Statutory Exemptions from U.S.-Situs Status
2. Estate Tax Treaty Exemptions
a. Broad Estate Tax Treaties
b. Other Estate Tax Treaties
B. Typical Assets that Are Owned by a Foreign Holding Company
C. Essential for the NRNC to Respect the Foreign Holding Company's Separate Status
D. Section 2104(b) Risk If Existing U.S.-Situs Assets Are Contributed to a Foreign Holding Company
E. U.S. FIT Consequences to Foreign Holding Company
1. Substantive U.S. Tax Liability
a. Income Realized by the Foreign Holding Company
b. Income Realized by the NRNC Owner from the Foreign Holding Company
2. Withholding on Income Realized by the Foreign Holding Company from U.S. Assets
F. Foreign Income Tax Consequences to the Foreign Holding Company and to the NRNC
G. Use of a Check-the-Box Partnership
H. Use of an Actual Partnership Without a Check-the-Box Election
1. FET Considerations
2. Qualification of the Entity as a "Partnership" for U.S. Tax Purposes
3. Section 2104(b) Issue
4. Tax Basis of the Partnership's Underlying Assets After Death
I. Inheritance of Foreign Holding Company Stock by the NRNC's Heirs
J. Formation of a Foreign Trust to Own a Foreign Holding Company
IV. Inheritance of Foreign Holding Company Stock by a U.S. Person
B. Tax Basis of the Foreign Holding Company Stock under § 1014
1. General Rule - Step-up to Fair Market Value on Date of Death
2. Exception for Stock of a FPHC
a. Investment by the Foreign Holding Company Only in Securities
b. Investment by the Foreign Holding Company in Tangible Personal Property
3. Passive Foreign Investment Company (PFIC) Rules
4. No Denial in Basis Step-Up for a CFC
5. Foreign Investment Company (FIC) Rules of § 1246
C. Taxation of the Foreign Holding Company's Post-Death Income If It Is Not Liquidated
1. The CFC/Subpart F Rules
2. The FPHC Rules
3. The PFIC Rules
D. Advantages to the U.S. Heirs of Liquidating the Foreign Holding Company
1. Foreign Holding Company that Owns Investment Assets
2. Foreign Holding Company that Owns Tangible Personal Property
E. U.S. Tax Consequences of an Actual or Deemed Liquidation of the Foreign Holding Company
1. Liquidation of a Foreign Holding Company that Owns Investment Assets
a. CFC and FPHC Rules, Where the Foreign Holding Company's Stock Basis Is Stepped Up at Death
b. FPHC Rules, Where there Is No Step-up at Death
c. Where the Foreign Holding Company Is a PFIC After Death
d. Where the Foreign Holding Company Is a FIC After Death
2. Liquidation of a Foreign Holding Company that Owns Tangible Personal Property
F. U.S. Tax Effects of a Check-the-Box Election by the Foreign Holding Company
G. Sale of the Foreign Holding Company Stock Instead of Liquidation
1. Sale of a Foreign Holding Company that Owns Investment Assets
2. Sale of a Foreign Holding Company that Owns Tangible Personal Property
H. Tax Implications Where Foreign Holding Company Is Owned by a Foreign Estate
I. Advantages of Holding the Foreign Holding Company Stock Through a Foreign Trust
J. Inheritance of an Interest in a Foreign Partnership
V. Taxation of Foreign Trusts Where there Is No Foreign Holding Company
1. Fact Patterns
2. Classification of the Trust as a "Foreign Trust" for FIT Purposes
B. Foreign Trust that Is Revocable During the NRNC Grantor's Lifetime
1. U.S. Tax Rules upon the NRNC Grantor's Death
a. FET Exposure to the NRNC Grantor
(1) General Rule of § 2038
(2) FET Risk if the Foreign Trust's Assets Were Originally U.S.-Situs
(3) Three-Year Rule if Right To Revoke Is Renounced
b. Basis of the Foreign Trust's Assets After the Grantor Dies
2. FIT Rules
a. Substantive FIT Rules
b. IRS Reporting Rules for U.S. Beneficiaries
C. Foreign Trust that Is Irrevocable During the NRNC Grantor's Lifetime
(1) General Rules of § § 2035â€"2038
(2) FET Risk if the Foreign Trusts's Assets Were Originally U.S.-Situs
b. Basis of the Foreign Trust's Assets after the Grantor Dies
a. Grantor Trust Rules
b. Rules for Nongrantor Foreign Trusts
(1) Overview of FIT on Income of a Nongrantor Foreign Trust
(2) FIT on the Foreign Trust Itself
(a) Substantive FIT Rules
(i) U.S.-Source Fixed or Determinable Annual or Periodical Income (FDAP)
(ii) Effectively Connected Income (ECI)
(iii) Income that Is Exempt from FIT in the Foreign Trust's Hands
(b) Tax Return Filing Requirements
(3) FIT on the NRA Beneficiaries
(a) General Rules
(b) Distribution of Fixed or Determinable Annual or Periodical Income (FDAP)
(c) Distribution of Effectively Connected Income (ECI)
(d) Distribution of Income that Is Tax-Exempt to the Foreign Trust
(e) Income Tax Treaties
(f) The "Anti-Intermediary" Rules of § 643(h)
(g) Section 678 Powers Held by U.S. or NRA Beneficiaries
(4) FIT on the U.S. Beneficiaries
(a) Distributions Out of Current Year's DNI
(b) Distributions Out of Prior Years' UNI
(c) Credit for Foreign Income Taxes Paid by the Foreign Trust
(d) Credit for U.S. Taxes Imposed on the Foreign Trust
(e) IRS Procedural Requirements
(f) Tax-Exempt Municipal Bond Interest
(g) Loans to U.S. Beneficiaries under § 643(i)
(h) The "Anti-Intermediary" Rules of § 643(h)
(i) Section 678 Power Held by U.S. Beneficiary
(5) Pro Rata Rule for Distributions
(6) Distribution Planning
(7) Deduction of the Foreign Trust's Expenses for DNI Purposes
(8) The 65-Day Rule
(9) Taxable Year of a Foreign Trust for FIT Purposes
(10) In-Kind Distributions from a Foreign Trust
(11) Specific Gifts Payable in Not More Than 3 Installments
D. After the Grantor's Death, Where the Foreign Trust Is Kept Alive
1. U.S. Transfer Tax Issues
a. Powers of Appointment under § § 2041 and 2514
b. GSTT Issues
2. FIT Issues
b. Nongrantor Trust Rules
(1) Basis of Foreign Trust's Property under § 1014
(2) The "Anti-Intermediary" Rules of § 643(h)
(3) Section 678 Power of Appointment Held by U.S. Beneficiary
VI. Taxation of Foreign Trusts Where there Is a Foreign Holding Company
(2) FET Risk if the Foreign Trust's or Foreign Holding Company's Assets Were Originally U.S.-Situs
(3) Three-Year Rule if Right to Revoke Is Renounced
(1) FIT on the Foreign Trust Itself
(2) FIT on NRA Beneficiaries
(3) FIT on U.S. Beneficiaries
(a) Issues for U.S. Beneficiaries under the CFC, FPHC and PFIC Regimes
(i) The CFC (Subpart F) Rules
(ii) FPHC Rules
(iii) The PFIC Rules
(iv) Summary of the Anti-Deferral Rules
(b) FIT Issues for the U.S. Beneficiaries under the General Foreign Trust Rules
1. FET and FGT Issues
a. Basis of the Foreign Trust's Assets under § 1014
b. The U.S. Anti-Deferral Tax Regimes if the Foreign Holding Company Is Not Liquidated or Sold
c. Liquidation of the Foreign Holding Company
(1) The Foreign Holding Company Is a CFC After the Grantor Dies
(2) The Foreign Holding Company Is Not a CFC After the Grantor Dies
(3) Sale of the Foreign Holding Company Stock as an Alternative to Liquidation
VII. Use of "Dynasty Trusts" for U.S. Transfer Tax Planning Purposes
B. Avoidance of U.S. Transfer Taxes During the Life of the Foreign Trust
1. U.S. Beneficiaries
2. NRNC Beneficiaries
C. Accumulation of Income that U.S. Beneficiaries Don't Need
1. Reorganization of the Foreign Trust into a Domestic Trust
2. Formation of a "Pourover" Domestic Trust
D. Ownership by the Foreign Trust of Personal-Use Property
E. Loans to U.S. Beneficiaries
VIII. Planning by Aliens Moving Temporarily to the United States
B. Tax Planning to Minimize the Risk of FET on U.S.-Situs Assets
1. Exposure to FET
2. Utilization of a Foreign Holding Company
3. Utilization of a Foreign Partnership
4. Utilization of a "Drop-off Trust"
a. Guidelines for Minimizing FET on the Drop-off Trust
b. Grantor Trust Status for FIT Purposes
c. FGT Risk if Grantor Transfers U.S.-Situs Tangible Property
d. Planning To Ensure NRNC Status
e. "Unwinding" the Drop-off Trust After the Grantor Resumes NRA Status
f. Utilization of a Domestic Trust Rather than a Foreign Trust; the § 684 Regulations
g. Utilization of Term Insurance To Cover FET Exposure
C. Tax Planning To Minimize the Risk of Becoming a RNC
D. Tax Planning To Minimize FIT During RA Status
1. Offshore Cash Roll-up Funds
2. Gifting of Assets to a Trusted NRA
3. Gift of Assets to NRA, Who then Forms a Trust for the Donor or his Family
a. The "Give and Go Rule" of § 672(f)(5)
b. The Intermediary Rule of § 679
c. IRS Reporting Requirements
d. U.S. Tax Effects if the Trust Is Not a Grantor Trust
e. Non-applicability of § 684
f. Unwinding the Trust After the Alien's U.S. Stay Has Ended
4. Formation of a Foreign Trust for the Sole Benefit of NRAs
a. Grantor Cannot Be a Current or Potential Beneficiary
b. Indirect Distributions of Trust Property to the Grantor
(1) Formation of the Foreign Trust When the Grantor Is a RA
(2) Reporting of Large Foreign Gifts
d. Section 684 Issues
(1) Risk If Trust Is Formed After RA Status Begins
(2) Risk When the Grantor Again Becomes a NRA
e. Unwinding the Trust After the Alien's U.S. Stay Has Ended
5. Gift of Assets to NRA Who Forms a Foreign Trust Only for NRAs
6. Summary of the Various Trust Alternatives
a. Substance-Over-Form Risk
b. Foreign Tax Implications
7. Offshore Insurance Products
8. Standard U.S. Tax Planning Ideas Not Involving Offshore Vehicles
9. Investment in Active Foreign Corporation in a Low-Tax Country
IX. Planning by Aliens Moving Permanently to the United States
B. Use of a Permanent "Drop-off Trust" To Avoid U.S. Transfer Taxes Through the Date of Death
1. General Comments
2. FGT/GSTT Risk If the Grantor Is Already a RNC
3. Risk of FGT on Later Contributions to the Trust
4. Distributions from the Trust While the Grantor Is Alive
5. Classification of the Trust as a Grantor Trust for FIT Purposes
6. Section 684 Issues - Should the Trust Be Foreign or Domestic?
C. Continuation of the Drop-off Trust After the Grantor Dies
D. Avoiding FIT on Investment Income
3. Gift of Assets to NRA, Who then Forms a Trust for the Donor
6. Offshore Insurance Products
7. Standard U.S. Tax Planning Ideas for U.S. Citizens
X. Investment in U.S. Real Property
1. Types of Investments by NRNCs in USRPIs
a. Personal Residence in the United States
b. Personal Residence that Is Rented Out Part of the Time
c. USRPI that Is Full-time Investment or Business Property
2. Tax Objectives of the NRNC/NRA Owner of the USRPI
a. FIT on Rental Income
b. FIT on Gain from the Sale of the USRPI
c. U.S. Transfer Tax Objectives
B. Ownership of a U.S. Residence that Is Never Rented Out
1. Structuring to Avoid FET
a. Ownership Through a Foreign Holding Company
b. Ownership Through a Foreign Trust
c. Ownership Through a Foreign Partnership
d. Ownership Through a RPHC
2. Restructuring If the NRNC Originally Owns the USRPI Directly
a. Utilization of a Foreign Holding Company
b. Utilization of a Trust
c. Utilization of a Foreign Partnership
d. Formation of a RPHC
3. Must the NRNC Pay Rent to the Entity that Owns the U.S. Residence?
a. FIT Issue
b. FET Issue
4. FIRPTA Tax under § 897 on the Sale of the U.S. Property
a. Sale by the NRNC/NRA Himself
b. Sale by a Foreign Holding Company
(1) Regular Corporate Income Tax
(2) Branch Profits Tax (BPT)
(3) Taxation of Distributions by the Foreign Holding Company to its NRA Shareholders
(4) Can the NRA Argue that the Foreign Holding Company Was a Sham?
(5) Sale of the Foreign Holding Company Stock to a Buyer Who Will Not Liquidate It
c. Sale by a Nongrantor Foreign Trust
(2) FIT on the Foreign Trust's NRA Beneficiaries
(3) FIT on the Foreign Trust's U.S. Beneficiaries
d. Sale of Interest in a Foreign Partnership
e. Sale of USRPI Owned by a RPHC
(1) Sale of the USRPI by the RPHC
(2) Sale of the RPHC Stock by the NRA Shareholders
5. Inheritance of the Structure by a U.S. Person
a. U.S. Property Owned by a Foreign Holding Company
b. U.S. Property Owned by a Foreign Trust
c. U.S. Property Owned by a Foreign Partnership
d. U.S. Property Owned by a RPHC
C. Ownership of a U.S. Residence that Is Rented Out Part of the Time
D. Ownership of Full-Time Investment or Business Property
1. Structuring the Investment to Avoid FET
a. Use of a Foreign Holding Company
d. Direct Ownership of a RPHC by the NRNC
2. FIT on Rental Income
a. "First Tax" on the Rental Income
b. "Second Tax" on the After-Tax Rental Income
(1) USRPI Owned by a RPHC
(2) USRPI Owned by a Foreign Holding Company
(3) USRPI Owned by a Foreign Trust
3. Restructuring if the NRNC Originally Owns the USRPI Directly
4. FIT on the Eventual Sale of the USRPI
a. Sale by a Foreign Holding Company
(1) USRPI Operated in Branch Form
(2) USRPI Held Through a RPHC Subsidiary
b. Sale by a Nongrantor Foreign Trust
(1) USRPI Held Directly by the Foreign Trust
(2) USRPI Owned Through a RPHC
c. Sale of Interest in a Foreign Partnership
d. Sale of USRPI Owned by a RPHC
XI. Maintaining an Investment Account in a Tax Haven
B. Fiduciary and Transferee Liability for Unpaid FET
C. The Post-2000 § 1441 Regulations
D. FET Aspects of the § 1441 Regulations
E. Formation of a Structure that May Legitimately Avoid FET
XII. Individuals Who Are Resident in a Tax Haven
B. Foreign Tax and Other Issues
1. Taxation in the Individual's Former Country of Residence
2. Taxation in the Tax Haven Country
a. Countries with Little or No Income Tax
b. High-Tax Countries with Special Tax Regimes
(1) The United Kingdom and Similar Remittance-Based Countries
(2) Switzerland
(3) Canada
(4) Other High Tax Countries
3. Non-tax Issues in the Country of Residence
4. Taxation of the Individual's Investments in Third Countries
C. Effect of the U.S. "Anti-Expatriation" Rules
1. General Rules
2. FIT on Disposal or Removal of Existing U.S. Assets
a. U.S. Investment Assets
b. Removal of Tangible Personal Property from the United States
c. U.S. Real Property
3. Continued Investment in U.S. Assets
a. Stock in U.S. Corporations
b. U.S. Debt Obligations
c. Ownership of U.S. Securities Through an Offshore Mutual Fund
d. U.S. Real Property
e. Ownership of U.S. Assets Through Non-corporate Entities
(1) Ownership Through a Foreign Partnership
(2) Ownership Through a Foreign Trust
f. Ownership of U.S. Assets Through an Offshore Insurance Product
XIII. Offshore Insurance Products
1. Variable Life Insurance Products
2. Variable Annuities
B. NRNC/NRAs with No U.S. Personal Contacts
1. Variable Life Insurance
C. NRNC/NRA Investors with U.S. Heirs
D. NRNCs Moving Temporarily to the United States
E. NRNCs Moving Permanently to the United States
F. U.S. Citizens and RNC/RAs
G. Expatriates Subject to § 877
XIV. Charitable Organizations Based in a Tax Haven
B. FIT Rules if the Entity Is Not Tax-Exempt
C. FIT Rules if the Entity Claims Tax Exemption
1. Establishing the FIT exemption
2. Substantive FIT Rules if it Is Exempt
3. Withholding Tax Rules under § § 1441 and 1443
4. Special Problems in Claiming Tax Exemption
5. U.S. Tax Return Filing Requirements
D. Applicability of the Private Foundation Rules
E. Distributions to U.S. Persons
F. Bequests by U.S. Citizens and RNCs to Tax Haven Private Foundations
Working Papers
Table of Worksheets
Worksheet 1 Chart Summarizing Incidence of U.S. Federal Transfer and Income Tax on Individuals Based on Residency Status
Worksheet 2 Diagram Illustrating Basic Foreign Holding Company Structure for Investment in U.S. Assets by NRNC
Worksheet 3 Diagram Illustrating Basic Foreign Trust Structure for Investment in U.S. Assets by NRNC
Worksheet 4 Diagram Illustrating Foreign Trust/Foreign Holding Company Structure for Investment in U.S. Assets by NRNC
Worksheet 5 Chart Summarizing Tax Issues for Individuals Investing in Variable Life Insurance Policies or Variable Annuity Contracts: Off-Shore Vs. U.S.-Based Insurance Companies
Bibliography
OFFICIAL
Internal Revenue Code
Regulations
Statutes
Legislative Documents
IRS Documents
Cases
Books and Treatises
UNOFFICIAL
Periodicals
1986
1989
1992
1993
1995
1997
1998
1999
2000
2001
2002
2003
2005