The Branch-Related Taxes of Section 884 (Portfolio 6480)

Tax Management Portfolio, The Branch-Related Taxes of Section 884, analyzes the branch-related taxes of §884, i.e., the branch profits tax, the branch level interest withholding tax, and the excess interest tax.

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These taxes may be applicable to a foreign corporation engaged in a trade or business in the United States (in addition to the regular corporate income tax, which is imposed on the taxable income of the foreign corporation effectively connected with its U.S. trade or business).

The branch-related taxes of §884 are imposed with respect to three separate tax bases: (1) U.S. trade or business earnings and profits deemed to be repatriated by the foreign corporation (the “dividend equivalent amount”); (2) interest deemed to be paid by the branch; and (3) interest that is deductible by the foreign corporation, but is not deemed to be paid by the branch (“excess interest”). The Portfolio describes in depth the calculation of the branch-related taxes and in addition addresses a number of other issues, including: (1) the effect of corporate reorganizations and other nonrecognition transactions on the branch profits tax; (2) the interplay between the tax on interest deemed paid by the branch and the excess interest tax; (3) the effect of treaty provisions on the branch-related taxes and (4) the impact of the OECD Report on the Attribution of Profits to Permanent Establishments on the branch-related taxes.

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The Branch-Related Taxes of Section 884 was authored by the following experts.
Peter J. Connors, Catholic University (B.A. 1973); University of Richmond (J.D. 1976); New York University (LL.M. 1979); CPA, New York; member, New York Bar, Section of Taxation of American and New York State Bar Associations, author, 543 T.M., The Mark-to-Market Rules of Section 475; Chair, Committee on Financial Transactions and Committee on Government Submissions, American Bar Association Section of Taxation; member, Tax Shelter Task Force, American Bar Association Section of Taxation; Vice Chair, Committee on Operations, American Bar Association Section of Taxation; Vice President, New York Chapter, International Fiscal Association; fellow, American College of Tax Counsel, Executive Committee, New York State Bar Association Tax Section, 2006 to present; partner, Orrick, Herrington & Sutcliffe LLP, New York, NY.


Detailed Analysis

I. Introduction

A. General Description of the Branch-Related Taxes of § 884

B. Prior Law

C. Genesis of the Branch-Related Taxes of § 884

D. The Regulations

II. Branch Profits Tax

A. Imposition of Tax and Rate

1. General

2. U.S. Trade or Business

3. Rate of Tax

4. Reporting

B. Tax Base

1. Dividend Equivalent Amount

2. Effectively Connected Earnings and Profits ("ECE& P")

a. Earnings and Profits ("E& P")

b. Effectively Connected with a U.S. Business

C. Determination of U.S. Net Equity

1. U.S. Assets

a. General Definition of U.S. Asset

b. Amount Included

c. Specific Inclusions in U.S. Assets

(1) Depreciable and Amortizable Property

(2) Inventory

(3) Installment Obligations

(4) Accounts Receivable

(5) U.S. Real Property Interests

(6) Bank and Other Deposits

(7) Securities Held in Banking or Similar Business

(8) Other Debt Instruments

(9) Federal Income Taxes

(10) Losses

(11) Involuntary Conversions

d. Partnership Interests

(1) Asset Method

(2) Income Method

(3) Election

(4) Tiered Partnerships

(5) Section 754 Elections

e. Trusts and Estates

f. Special Exclusions from U.S. Assets

g. Proposed Rules for Certain Financial Transactions

h. Proposed Global Dealing Regulations

2. U.S. Liabilities

a. Insurance Liabilities

b. Election to Reduce Liabilities

c. Proposed Regulations Relating to Financial Instruments

3. Anti-Abuse Rules

D. Termination of Branch

1. Termination of U.S. Trade or Business Activities

2. Elimination of All U.S. Assets

3. Reinvestment in U.S. Assets

a. Three-Year Prohibition on Reinvestment

b. Section 338 Elections

4. Effectively Connected Earnings and Profits

5. Special Rule for Income Under § 864(c)(6) or § 864(c)(7)

a. In General

b. Rulings

6. Procedural Requirements

a. Waiver of Statute of Limitations

b. Election to Remain Engaged in Business

7. Failure to Satisfy Termination Requirements

E. Reorganizations and § 332 Liquidations

1. General Rule

2. Domestic Transferee

a. Dividend Look-Back Rule

b. Stock Sale Reinvestment Rule

c. Waiver and Transferee Agreement

3. Special Problems

a. "F" Reorganizations

b. Divisive § 355 Transactions

F. Section 351 Transactions

1. Special Control Requirement

2. Effect on Transferor

3. Effect on Transferee

4. Procedural Requirements

a. In General

b. "No Disposition" Rulings

(1) Section 351 Transfer

(2) Section 368(a)(1)(D) Reorganization

(3) Section 368(a)(1)(E) Recapitalization

G. Section 355 Distribution of Domestic Subsidiary

H. Incorporation of Foreign Subsidiary

I. Liquidation or Reorganization of Domestic Subsidiary

1. Regulations Under § 367(e)(2)

2. Special Branch Profits Tax "Carryover" Rules

a. First Carryover Rule

b. Second Carryover Rule

III. Branch Interest Withholding Tax

A. Scope and Application

1. U.S. Source Income Rule

2. Statutory Withholding Tax and Exemptions

3. Treaty Relief

4. Interaction with Partnership Interest Sourcing Rules

B. Definition of Branch Interest

1. General

2. Liabilities Relevant to Calculation of Branch Interest

a. Definition of Booked Liability

b. Ruling

C. Special Rules Affecting Amount of Branch Interest

1. Increase in Branch Interest for 80% U.S. Businesses

2. Special Scaleback Rule for Branch Interest in Excess of Amounts Allocable to ECI

3. Election to Treat Interest as Paid in Year of Accrual

a. Interest Paid and Accrued in Different Years

b. Interest Accrual Earlier Than Year of Payment

c. Interest Paid in Advance of Accrual

d. Form of Election

IV. Tax on Excess Interest

A. Application

1. Purpose

2. Operation

a. General

b. Interaction with Earnings-Stripping Rules

3. Statutory Exemption

a. Bank Deposit Interest

(1) In General

(2) Rulings

b. Other

4. Treaty Relief

5. Stapled Entities

B. Determination of Excess Interest

1. Interest Allocated to ECI (Regs. § 1.882-5)

a. Overview of Regs. § 1.882-5

b. Direct and Special Allocations

c. Allocation of Interest Expense to U.S. Operations

(1) Step One - U.S. Assets

(a) Anti-Abuse Rule

(b) Partnership Interests

(c) Valuation

(2) Step Two - U.S.-Connected Liabilities

(a) General

(b) Rulings

(c) Planning Considerations Resulting from Ratio and Value Elections

(d) Section 884 Election to Reduce Liabilities

(e) Short sales

(3) Step Three - Interest Expense Allocable to ECI

(a) 1980 Regulations

(b) U.S. Booked Liabilities Equal or Exceed U.S.-Connected Liabilities

(c) U.S.-Connected Liabilities Exceed U.S. Booked Liabilities

(d) Separate Currency Pools Method

(4) Proposed Regulations Relating to Financial Instruments

(5) Substitute Payments

(6) Elections Under Regs. § 1.882-5

2. Reduction for Branch Interest

a. General

b. Partnership Interest Expense

V. Application of U.S. Tax Treaties

A. Branch Profits Tax

1. LOB/Qualified Resident Requirement

2. 36-Month Rule

3. Special Rules for Canadian Corporations

4. Treaty Nondiscrimination Provisions

5. Congressional Override of Treaties in Treaty-Shopping Cases

6. The U.K. Treaty

7. Reverse Hybrid Entities

B. Branch Interest Withholding Tax

1. Applicable Treaty

2. LOB/Qualified Resident Requirement

a. General

b. Qualified Resident in Preceding Year

c. Short-Term Obligations

d. Interest Paid by Partnership

C. Tax on Excess Interest

1. Availability of Treaty Benefits

2. Treaty Nondiscrimination Provisions

D. Qualification Under Post-1986 Treaty LOB Article

1. Germany

2. Mexico

3. Netherlands

a. Publicly-Traded Companies

b. Companies Owned 50% by Qualifying Shareholders and Meeting the Base Erosion Test

c. Companies with Active Trade or Business

(1) Trade or Business

(2) Derived "in Connection with"

(3) Substantiality

(4) Election with Respect to Activities in Other EU Countries

d. Headquarter Companies

e. The 2004 Protocol

(1) Publicly-Traded Companies

(2) Companies Owned 50% by Qualifying Shareholders and Meeting the Base Erosion Test and Derivative Benefits

(3) Companies with Active Trades or Businesses and Headquarter Companies

4. 1996 U.S. Model

a. Publicly-Traded Companies

b. Companies Owned 50% by Qualifying Shareholders and Meeting the Base Erosion Test

c. Companies with Active Trade or Business

(1) Trade or Business

(2) Derived "in Connection with"

(3) Substantiality

d. Competent Authority Determination

5. United Kingdom

a. Publicly-Traded Companies

b. Derivative Benefits

c. Conduct of an Active Trade or Business

d. Competent Authority Relief

e. Tracking Stock

E. Qualified Resident Status Under Regs. § 1.884-5

1. Stock Ownership/Base Erosion Test

a. Stock Ownership Rules

b. Base Erosion Rules

c. Qualifying Shareholders

(1) General

(2) Publicly-Traded Classes of Stock

(3) Not-for-Profit Organizations

(4) Pension Funds

d. Constructive Ownership of Stock

(1) General

(2) Attribution from Corporations

(3) Attribution from Partnerships

(4) Attribution from Trusts and Estates

(5) Attribution from Mutual Companies

e. Documentation Requirements

(1) General

(2) Dispensation from General Documentation Requirements

(a) Registered Shareholders of Widely-Held Corporations

(b) Reasonable Cause Exception to Due Dates

(c) IRS Ruling

(3) Ownership Statements

(4) Certificate of Residency

(5) Intermediary Ownership Statements

(6) Intermediary Verification Statements

f. Special Rules for Pension Funds

(1) Non-Government Pension Funds

(2) Government Pension Funds

g. Retention of Documentation

2. Publicly-Traded Corporation Test

a. Established Securities Market

b. Primarily and Regularly Traded

(1) Regularly Traded

(2) Primarily Traded

c. Compliance

3. Active Business Test

a. General

b. Active Conduct of a Trade or Business

c. Substantial Presence

(1) Asset Ratio

(2) Gross Income Ratio/Material Costs Ratio

(a) Gross Income Ratio

(b) Material Costs Ratio

(3) Payroll Ratio

d. Integral Part of an Active Trade or Business

(1) General

(2) Bank Presumption

(3) Partial Qualification

(4) Appropriateness of the "Integral Part" Standard

(5) IRS Rulings

e. Interest Received

f. Affiliated Group

4. Qualified Resident Ruling

a. General

b. Rulings Issued

(1) Stock Ownership/Base Erosion Test

(2) Publicly-Traded Corporation Test

(3) Active Business Test

VI. Branch Reporting Requirements


Working Papers

Table of Worksheets

Note: The income tax treaties discussed in this Portfolio may be found in the Worksheets of the relevant Tax Management Foreign Country Portfolios.

Worksheet 1 T.D. 8432, 1992-2 C.B. 157 Preamble to Branch Profits Tax Regulations

Worksheet 2 T.D. 8657, 1996-1 C.B. 153, Preamble to Branch Profits Tax Regulations

Worksheet 3 T.D. 8658, 1996-1 C.B. 161, Preamble to Interest Expense Regulations

Worksheet 4 H.R. Rep. No. 426 99th Cong., 1st Sess. 431â€"435 (1985)

Worksheet 5 S. Rep. No. 313, 99th Cong., 2d Sess. 400â€"407 (1986)

Worksheet 6 H.R. Rep. No. 841 (Conference) 99th Cong., 2d Sess. IIâ€"646â€"650 (1986)

Worksheet 7 Staff of the Joint Committee on Taxation General Explanation of the Tax Reform Act of 1986 99th Cong., 2d Sess. 1035â€"1047 (1987)

Worksheet 8 H.R. Rep. No. 795, 100th Cong., 2d Sess. 281â€"287 (1988)

Worksheet 9 S. Rep. No. 445, 100th Cong., 2d Sess. 296â€"301 (1988)

Worksheet 10 Excerpt from Form 1120-F, Section III - Branch Profits Tax and Tax on Excess Interest



Internal Revenue Code:

Public Laws:

Legislative History:

Other Legislative Background:


Treasury Regulations:

Revenue Rulings and Revenue Procedures: