U.S. Inbound Business Tax Planning (Portfolio 6580)

Tax Management Portfolio, U.S. Inbound Business Tax Planning, is a practical planning guide for structuring foreign investment into the United States. It presents a cross-disciplinary approach based on the experience of practitioners in the areas of U.S. international tax, transfer pricing, and state and local tax.

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The Portfolio addresses topics that are most relevant to foreign-based multinational corporations doing business in the United States. They include a framework of U.S. inbound income taxation, state tax, formation of a U.S. business, financing U.S. operations, ownership of intangible property, and inbound acquisitions and restructurings.


U.S. Inbound Business Tax Planning was authored by the following experts.
Bernard Moens, Esq.

Bernard Moens, LL.M. (Tax), New York University School of Law; LL.M. (General), University of Chicago Law School; Lic. Iur. (magna cum laude), University of Antwerp, Belgium; Member, New York State Bar Association; Member, International Fiscal Association; Member, American Bar Association; Adjunct Professor, Georgetown University Law School.

Joseph Andrus, Esq.

Joseph Andrus, J.D., University of Chicago Law School; B.S., Brigham Young University; Member, International Fiscal Association; Member, American Bar Association Tax Section; Member, D.C. Bar Tax Section; former Adjunct Professor, Graduate Tax Programs at Chicago Kent College of Law and Boston University School of Law. Mr. Andrus retired from PricewaterhouseCoopers and was appointed head of the Transfer Pricing Unit within the Tax Treaty, Transfer Pricing and Financial Transactions Division of the OECD Center for Tax Policy and Administration.

Sidney Silhan, CPA, CMA, MST, JD

Sidney Silhan, J.D. (highest honors), Chicago-Kent College of Law; M.S., DePaul University; B.S., Northern Illinois University; CPA; CMA.

Table of Contents

Portfolio Description


Technical Advisors


Detailed Analysis

I. Introduction

Introductory Material

A. U.S. Inbound Income Taxation — A Framework

B. State Tax Considerations

C. Formation of a U.S. Business

D. State Tax Credits and Incentives

E. Financing U.S. Subsidiary Operations — The Fundamentals and Planning

F. Ownership of Intangibles

G. Inbound M& A, Dispositions, and Restructurings

II. U.S. Inbound Income Taxation — A Framework

Introductory Material

A. Is the Person Earning the Income a Non-U.S. Person?

B. Is the Income Earned by the Non-U.S. Person U.S.-Source Income?

1. Sourcing Rules Generally

2. Interest

3. Dividends

4. Rents and Royalties

5. Gains from the Sale or Exchange of Property

6. Insurance Income

7. Compensation

8. Guarantee Fees

C. Income Effectively Connected with a U.S. Trade or Business

1. U.S. Trade or Business

a. Agency

b. Statutory Exceptions

c. Holding Companies and Senior Management Functions

2. Effectively Connected Income

a. U.S.-Source Income that Is Not Passive-Type Income

b. Passive-Type U.S.-Source Income

(1) Asset-Use Test

(2) Business-Activities Test

c. Certain Foreign-Source Income

d. Allocation and Apportionment of Deductions to Gross Effectively Connected Income

(1) Non-Interest Expense

(2) Interest Expense — Foreign Corporations

(3) Interest Expense — Nonresident Individuals

3. Branch Taxes

a. Branch Profits Tax

b. Branch Interest Tax

4. Permanent Establishment Treaty Concept

D. U.S.-Source Passive-Type Income (FDAP income)

1. Portfolio Interest Exception

2. Bank Deposit Exception

3. Exception for 80/20 Companies (for Taxable Years Beginning Before 1/1/11)

4. Exception for 80/20 Companies (for Taxable Years Beginning After 12/31/10)

E. Foreign Investment in U.S. Real Property

F. U.S. Income Tax Treaty Considerations

III. State Tax Considerations

A. Types of State Taxes

1. Income

2. Gross Receipts/Business and Occupation

3. Franchise/Net Worth

4. Personal and Real Property

5. Sales

6. Use

7. Real Property Transfer

8. Employment

B. Determining Nexus/Subjectivity to Tax

1. In General

a. Fact Dependent

b. Taxes Not Mutually Exclusive

2. Due Process Clause

3. Commerce Clause

a. Economic Presence Nexus

b. Agency Nexus

(1) In General

(2) Attributional Nexus

4. Statutory Limitation (P.L. 86-272)

5. Treaty Application to State Taxation

6. Foreign Commerce Clause Nexus

C. State-Federal Interaction

D. Variability in Taxation Among States

1. Income Tax

2. Description of "Typical" State Taxation Approach

a. Overview of "Typical" State Taxation Approach

b. Starting Point

c. Modifications

d. Distinctions Between Business and Nonbusiness Income

e. Allocation of Nonbusiness Income

f. Apportionment of Business Income

g. Net Operating Losses

h. Tax Rate

3. Variation in State Filing Methods, Determination of Taxable Income, and Apportionment Methodologies

a. Separate Reporting Method

b. Consolidated Reporting Method

c. Combined Reporting Method

4. Overview of Four "Model" States

a. California

(1) State Taxable Income Starting Point

(2) Worldwide/Water's-Edge Reporting

(3) Dividend Issues

(a) Cal. Rev. &  Tax. Code § 24402

(b) Cal. Rev. &  Tax. Code § 25106

(c) Cal. Rev. &  Tax. Code § 24411

(d) Ordering of Distributions

(4) Apportionment Issues

b. New York

(1) State Taxable Income Starting Point

(2) Combined Worldwide Reporting of Foreign and Domestic Entities

(3) Inclusion of Foreign-Source Income

(4) Apportionment Issues: The Finnigan Rule

c. Illinois

(1) State Taxable Income Starting Point

(2) 80/20 Companies

(3) Joyce Rule

d. New Jersey

(1) State Taxable Income Starting Point

(2) Provisions Unique to New Jersey

(a) Nexus Standards

(b) Throw-out Sales

(3) Disregard of U.S. Income Tax Treaties

(4) Alternative Minimum Assessment

IV. Formation of a U.S. Business

A. Relevance

B. U.S. Presence

1. No Physical U.S. Presence

2. Physical U.S. Presence

C. U.S. Branch vs. U.S. Subsidiary

1. U.S. Branch Overview

a. Federal Taxation of a U.S. Branch

b. State Taxation of LLCs and Branches

2. Turning a Branch into a Corporate Subsidiary

3. U.S. Subsidiary Overview

a. Federal Taxation of a U.S. Subsidiary

b. State Taxation of a U.S. Subsidiary

D. Investing Through a U.S. Partnership

1. U.S. Partnership Overview

2. Federal Taxation of a U.S. Partnership

3. State Taxation of a U.S. Partnership

E. Examples

1. Minimal U.S. Presence

2. Greater U.S. Presence

3. Substantial U.S. Presence

F. Key Compliance Considerations Specific to Inbound Investments

1. Federal Employer Identification Number

2. Form 1120-F

a. Foreign Corporation Engaged in a U.S. Trade or Business

b. Branch Profits Tax

c. When to File Form 1120-F

d. Protective 1120-F Filings

3. Form 5472

4. U.S. Corporation Compliance

5. U.S. Partnership Compliance

G. U.S. Withholding Regime

1. Withholding of Tax on Foreign Corporations and Nonresident Aliens

a. Withholding Exemptions

b. Foreign Corporations and Nonresident Aliens

c. Foreign Tax-Exempt Organizations

d. Dispositions of U.S. Real Property Interests

(1) General Rule

(2) Exception for Non-U.S. Real Property Holding Corporations

(a) Company Statement

(b) IRS Determination

(3) Zero Withholding Liability

(4) Partnership Implications

e. Foreign Partners' Share of Effectively Connected Income

f. Principal Penalties

g. Withholding Information Reporting Compliance

2. Foreign Account Tax Compliance Act (FATCA)

V. State Tax Credits and Incentives

A. Introduction

B. Trends in Credits and Incentives

C. Primary Drivers for Credit and Incentive Opportunities

D. Research and Development (R& D) Tax Credits

E. Job Creation Tax Credits

F. Investment Tax Credits (ITCs)

G. Employee Training Credits and Incentives

H. Sustainability or "Green" Tax Credits and Incentives for Environmental Conservation and Energy-Efficient Projects

I. Targeted Economic Development Area Benefits

J. Sales and Use Tax Exemptions

K. Freeport Exemption

L. Foreign Trade Zones

M. Negotiable Incentives

1. Utility Incentives

2. Free or Discounted Land or Building

3. Bond Financing

N. Key Considerations for Companies in Planning and Negotiating Discretionary Incentives

1. Preserving Optimal Leverage

2. Understanding Required Commitments Associated with Each Program

O. Best Practices for Securing and Maintaining Economic Development Credits and Incentives

1. Confirm that Incentives Offered for a Project Can Actually Be Utilized or Monetized

2. How to Avoid a Bad Incentives Deal

3. Apportionment Factors and Future Changes in Tax Laws

4. Transferability of Unused Credits and Incentives

VI. Financing U.S. Subsidiary Operations — The Fundamentals

Introductory Material

A. Overview

B. Relevance

C. Debt-Equity Framework in the Related Party Context

1. Statute: Section 385

2. IRS Notice

3. Case Law

4. Factors

a. Unconditional Entitlement to Receive Payment at a Fixed Maturity Date

b. Right to Enforce Payment

c. Likelihood and Expectation of Repayment

d. Independent Creditor

e. Cash Flows

f. Thin Capitalization of Borrower

g. Subordination of Rights of the Lender to General Creditors of the Borrower

h. Right to Participate in Management of the Borrower

i. Identity Between Lender and Shareholders of the Borrower

j. Label Placed on the Instrument

k. Treatment for Nontax Purposes

5. Interest Deductibility

a. In General

(1) Definition of Interest

(2) Paid or Accrued

(3) Indebtedness

b. Limitations

(1) Section 163(j)

(a) Debt-to-Equity Ratio Safe Harbor

(b) Computation of Deferred Interest

(i) Disqualified Interest

(A) Treaty Reduction

(B) Disqualified Guarantee

(ii) Excess Interest Expense

(c) Various Legislative Proposals Regarding § 163(j)

(d) Form 8926

(2) Section 267(a)(2)

(a) Interest Income

(b) All Other Income

(3) Section 163(e)

(4) Section 163(l)

D. Cancellation of Subsidiary Debt

1. Cancellation of Debt Income

2. Significant Modification of a Debt Instrument

3. Withholding on Deemed Interest Payment

4. Conversion of Interest into Principal

5. Loans to U.S. Branches

a. Branch Profits Tax

b. Potential Entity Classification Impacts of Debt Capitalization

E. State Tax Issues

1. Net Worth Taxes

2. Income Tax Deductibility for Debt

3. Cancellation of Debt Issues

a. Contribution/Distribution Transaction

b. Contribution Transaction (Parent Forgives Subsidiary's Debt)

c. Distribution Transaction (Subsidiary Forgives Parent's Debt)

d. Offsetting Intercompany Accounts Within an Affiliated Group

e. Cancellation of Debt May Create Taxable Income

4. Cash Repatriation and Withholding Issues

5. Issues Surrounding Dividends Received Deduction for Payments from Lower-Tier Subsidiaries

a. State Variations on § 243 Deductions

b. Earnings and Profits Differences Between State and Federal

VII. Financing U.S. Subsidiary Operations — Planning

A. Cross-Border Hybrid and Other Financing Transactions

1. Overview

2. Triangular Branch Financing

3. Hybrid Instruments

a. Hybrid Instruments Treated as Debt

(1) Sale and Repurchase (Repo) Transactions

(2) Notice 94-47/Rev. Rul. 85-119

(3) Preferred Securities — CCA 200932049

b. Hybrid Instruments Treated as Equity

B. Guaranteed Third-Party Debt

1. Plantation Patterns

a. Examination of Credit and Reliance upon Collateral

b. Thin Capitalization

c. Ability to Secure Alternative Financing

2. Practical Application

C. Common Law Doctrines

1. Strong Proof/Danielson Rule

2. Sham Transaction

3. Business Purpose

4. Codified Economic Substance

D. Treaty-Related Provisions in the Code and Regulations

1. Domestic Reverse Hybrid Treatment Under § 894

2. Denial of Treaty Benefits for Certain Payments Through Hybrid Entities Under § 894(c)

3. Conduit Financing Rules

a. Cases

b. Revenue Rulings

c. Regulations

(1) Does a Financing Arrangement Exist?

(2) Does a Conduit Financing Arrangement Exist?

(3) Disregarded Intermediate Entity

(4) Tax Avoidance Plan

(5) Time Elapsed

(6) Use of an Intermediate Branch

(7) Issuance of Foreign Public Debt

(8) Guaranteed Debt

(9) Regulations on Hybrid Entities

VIII. Ownership of Intangibles

Introductory Material

A. Development and Continuing Ownership of Intangibles

1. Research and Development Activities

2. Licensing Arrangements

3. Cost Sharing Arrangements

4. Sales and Distribution Models and the Ownership of Marketing Intangible Returns

B. Acquisition of Intellectual Property

1. U.S. vs. Outside U.S.

2. Choice of Sales/Distribution Model

3. Amortization Deductions

4. Advance Pricing Agreements

5. IP Transactions and Potential State Disallowance of Deduction

a. State Authority to Disallow Deductions

(1) Add-Back Statutes

(2) Forced Combination

(3) Transaction Adjustment Authority

(4) Economic Nexus

b. Deduction for Royalties if Located Overseas

IX. Inbound M& A, Dispositions, and Restructurings

Introductory Material

A. Acquisitions

1. Taxable Acquisitions

a. Asset Purchase

(1) Foreign Parent Buys U.S. Target Assets

(2) U.S. Parent Buys U.S. Target Assets

b. Stock Purchase

(1) Election Under § 338

(a) Section 338(g) Elections

(b) Section 338(h)(10) Elections

(2) Foreign Parent Buys U.S. Target Stock

2. Tax-Free Acquisitions

a. Tax-Free Asset Acquisitions

(1) Mergers

(2) "C" Reorganizations

(3) "D" Reorganizations

b. Tax-Free Stock Acquisitions

3. Redemption Through Related Corporations

a. Section 304(a)(1)

b. Section 304(a)(2)

c. Rules Applicable to § 304(a)(1) and (2)

B. Outbound Spin-Offs, Split-Offs, and Split-Ups

1. General Rules Under § 355

a. Control Requirements for Tax-Free Treatment Under § 355

b. Five-Year Active Conduct of a Trade or Business Requirement

c. Distribution

d. Devices

e. Continuity

f. Business Purpose

2. Special Rules under § 355

a. Disguised Sales — § 355(d)

b. Disguised Sales — § 355(e)

c. Intragroup Spin-Offs — § 355(f)

d. Cash Rich Split-Offs — § 355(g)

3. Application of § 367 to Outbound Spin-Offs

a. Outbound Spin-Off of a U.S. Corporation

b. Outbound Spin-Off of a Foreign Corporation

(1) Treatment of Distributing Corporation

(2) Treatment of Distributees

4. Interaction with FIRPTA Rules

C. Rules Relating to Expatriated Entities and Their Foreign Parents

D. Outbound Liquidations

1. General Rules Applicable to Corporate Liquidations

2. Liquidation of a U.S. Holding Company

3. Application of § 367 to Outbound Liquidations

a. Liquidation of U.S. Subsidiary into Foreign Parent

(1) General Rule

(2) Exceptions

(a) Distribution of Certain Property Used in a U.S. Trade or Business

(b) Distribution of Certain U.S. Real Property Interests

(c) Distribution of Stock of a U.S. Subsidiary Corporation

(3) General Anti-Abuse Rule

b. Distribution by a Foreign Corporation to a Foreign Distributee

(1) Liquidating Corporation Owns Shares in a U.S. Corporation

(2) Liquidating Corporation Owns U.S. Trade or Business Assets

(a) Property Ceases to Be Used in a U.S. Trade or Business

(b) Property Was Formerly Used in a U.S. Trade or Business

E. State Tax Issues in Connection with Inbound M& A

1. Holding Company Structure Issues

a. Unitary Business Issues

b. Transfer Pricing Issues

c. Acquisition Indebtedness

d. Instant Unity

e. Tax Attribute Issues

(1) Section 382 Limitations

(2) NOL Attribute Ownership — § 338(h)(10) Issues

2. Credits and Incentives

3. Successor Liability Issues

Working Papers

Working Papers

Table of Worksheets

Worksheet 1 Decision Tree: Framework of U.S. Inbound Income Taxation

Worksheet 2 Debt/Equity Factors

Worksheet 3 Strong Proof and Danielson Standards