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By Edward Tanenbaum, Esq.
Alston & Bird LLP, New York, NY
A pair of interesting private letter rulings was released a few weeks ago dealing with the interpretation of the Independent Personal Services article of the U.S.-Russian Federation Income Tax Treaty ("the Treaty"). Although perhaps not earth-shattering, these rulings confirm that the IRS will consider income earned in the United States by a nonresident alien member of a service partnership as taxable in the United States even though the member himself is not physically present in the United States, unless the terms of a treaty pertaining to independent personal services expressly require physical presence in the United States by the nonresident alien.
In PLR 201028026 and PLR 201028027, the IRS ruled that the distributive share of income of a nonresident alien residing in Russia from a partnership operating in the United States, but with offices in Russia, will be exempt from U.S. tax under Article 13 (Independent Personal Services), provided that the nonresident alien is not present in the United States for more than 183 days during the calendar year.
This may sound like an obvious conclusion based on a clear reading of Article 13, but this is an area with a somewhat tortured history and, as is often the case with treaty provisions, the treaty language is not always that clear.
Nonetheless, the facts in the two rulings are clear. The rulings involve a partnership which has a fixed base in the United States and a partner based in Russia. A portion of the Russian partner's distributive share of partnership income comes from the U.S. partnership activities. Under fairly well-established statutory principles, i.e., §875 of the Code, the Russian partner is deemed to be engaged in a U.S. trade or business within the United States (and, for treaty purposes, through a permanent establishment) if the partnership is so engaged. The issue is how the Independent Personal Services article of a treaty might change this result.
Read in the context of the PLRs, Article 13 of the Treaty essentially provides that income derived by a resident of Russia from the performance of independent personal services is taxable only in Russia unless the services are performed in the United States and the income is attributable to a fixed base which the individual has regularly available to him in the United States and the individual is present in the United States for a period exceeding 183 days. The rulings hold that because the partner was not in the United States for the required number of days, he is not taxable in the United States on his distributive share of partnership income.
You might be lulled into thinking that it makes perfect sense to tax a nonresident partner of a partnership with a fixed base in the United States if that partner is present in the United States for a significant period of time. However, you might be surprised to learn that under similar (but not identical) treaty articles, a nonresident partner may be taxed in the United States on his distributive share attributable to the United States even if he is not present in the United States at any time.
Back to the tortured history. It has not always been entirely clear whether the Independent Personal Services article could be read to tax a nonresident of the United States who is a partner in a partnership with a fixed base in the United States if that partner, himself, has not been present in the United States or has not actually performed services in the United States. On the one hand, it is difficult to understand why such a partner should be taxed. On the other hand, why should it matter whether that partner performed services in the United States as long as he/she is receiving partnership income attributable to a business being conducted in the United States by a partnership in which that person is a member. On the "other other" hand, a reading of the Independent Personal Services articles contained in some of the treaties does not easily get you there (i.e., taxability without physical presence).
Take the fact pattern presented in Rev. Rul. 2004-3.1 The Independent Personal Services article in the then U.S.-Germany Income Tax Treaty (but since deleted) basically provided that income realized by a German resident from the performance of independent personal services would be taxed only in Germany unless the services were performed in the United States and the income was attributable to a fixed base regularly available in the United States to the German resident for the purpose of performing his activities. In that ruling, a nonresident alien partner of a service partnership organized in Germany but with offices in the United States was held to be subject to U.S. tax based on his allocable share of income from the partnership attributable to the partnership's U.S. office, even though the nonresident alien performed services only in Germany.
Okay. So Helmut gets taxed even though he was never present in the United States performing services there? I don't think a quick reading of the article would necessarily lead you to that conclusion. But, according to Rev. Rul. 2004-3, the hidden meaning of the article needs to be understood, i.e., it is not relevant whether or not Helmut was present performing services in the United States; rather, as long as he derives income from the performance of independent personal services in the United States (by any partner of the partnership) and the income is attributable to a fixed base regularly available in the United States (even though the nonresident alien never actually availed himself of the fixed base in the United States), Helmut is taxed.
The holding in Rev. Rul. 2004-3 may not have always been that clear even to the IRS. In PLR 9331012, somewhat similar facts were dealt with, i.e., a German partnership with a U.S. office, although under the facts of that ruling the partnership agreement happened to have allocated all of the U.S. income to the U.S. resident partner. The IRS ruled, under the same Independent Personal Services article of the then U.S.-Germany treaty, that the non-U.S. resident partners were not taxable on their distributive shares attributable to the U.S. office because they did not perform any services in the United States. Not surprisingly, when Rev. Rul. 2004-3 was issued, the IRS also issued PLR 200420012, revoking PLR 9331012.
While many of our treaties have similar Independent Personal Services articles such as the then U.S.-Germany treaty article examined in Rev. Rul. 2004-3, there are a few treaties that require some form of physical presence as in the case of the U.S.-Russian Federation Income Tax Treaty. See, e.g., the U.S. treaties with Israel, Poland, and Egypt. Other treaties, e.g., those with Estonia, Latvia, Lithuania, and South Africa, provide that a fixed base is deemed to exist in the United States if there is physical presence of more than 183 days. The treaty with France requires actual performance of services in the United States. Other treaties call for U.S. taxation if there exists either a certain number of days of presence in the United States or the availability of a fixed base in the United States. See, e.g., Australia, China, Hungary, India, Mexico, Portugal, Turkey.
Finally, a few of our newer treaties have deleted the Independent Personal Services article altogether on the theory that the determination of whether there exists a fixed base in the United States is essentially the same as that for finding a permanent establishment and that the taxation of income from independent personal services is adequately dealt with in the Permanent Establishment and Business Profits articles. See, e.g., Belgium, Canada, and Ireland.
The two recent letter rulings once again confirm that the Independent Personal Services articles of many treaties will not prevent U.S. taxation of a nonresident alien partner who is not even present in the United States. At the same time, however, the rulings highlight that, in the case of certain other treaties, there is the additional requirement that the individual be present in the United States for a requisite number of days in order for his partnership income to be taxable.
This commentary also will appear in the October 2010 issue of the Tax Management International Journal. For more information, in the Tax Management Portfolios, see Bissell, 907 T.M., U.S. Income Taxation of Nonresident Alien Individuals, and Stoffregan, Harris, and Wirtz, 910 T.M., Partners and Partnerships — International Tax Aspects, and in Tax Practice Series, see ¶7130, Foreign Persons — Effectively Connected Income, and ¶7160, U.S. Income Tax Treaties.
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