International Tax FAQs

On March 18, 2010, Congress signed into law the Hiring Incentives to Restore Employment Act of 2010, Pub. L. 111-147, adding chapter 4 of Subtitle A (FATCA) to the Internal Revenue Code (sections 1471 through 1474).  Under FATCA, to avoid being withheld upon, foreign financial institutions (FFIs) may register with the IRS and agree to report to the IRS certain information about their U.S. accounts, including accounts of certain foreign entities with substantial U.S. owners

FFIs that enter into an agreement with the IRS to report on their account holders may be required to withhold 30% on certain payments to foreign payees if such payees do not comply with FATCA

A FATCA certification is a certification that the responsible officers of certain entities must providet to the IRS to confirm the entities’ compliance with the requirements of FATCA.  There are two general types of certifications:  one that relates to an entity’s preexisting accounts (COPA) and another that relates to the entity’s compliance with various FATCA requirements (periodic certification).

Yes, a U.S. citizen or a resident alien living outside the United States, is subject to U.S. income tax on worldwide income. However, such a taxpayer may qualify for certain foreign earned income exclusions and/or foreign income tax credits.

A green card holder is generally required to file a U.S. income tax return and report worldwide income.

International information return penalties are civil penalties assessed by the IRS against a United States person for failing to timely file complete and accurate international information returns required by specific Internal Revenue Code (IRC) sections.  Those information returns cover a broad spectrum of reporting obligations, and include IRS Forms 5471, 5472, 3520, 3520-A, 8938, 926, 8865, 8621, 8858 and others.

The FBAR regulations require that a United States person, including a citizen, resident, corporation, partnership, limited liability company, trust and estate, file an FBAR to report:

• a financial interest in or signature or other authority over at least one financial account located outside the United States if
• the aggregate value of those foreign financial accounts exceeded $10,000 at any time during the calendar year reported.

The report is required to be electronically filed with FinCEN on FinCEN Report 114, Report of Foreign Bank and Financial Accounts (FBAR).

There are various instances in which a U.S. person is deemed to have a financial interest in a foreign financial account. These include: (i) the U.S. person is the owner of record or holder of legal title, regardless of whether the account is maintained for the benefit of the U.S. person or another person; (ii) the owner of record or holder of legal title is a person acting as an agent, nominee, attorney, or a person acting on behalf of the U.S. person with respect to the account; (iii) the owner of record or holder of legal title is a corporation in which a U.S. person owns directly or indirectly more than 50% of the total value of shares of the stock or more than 50% of the voting power of all shares of stock; (iv) the owner of record or holder of legal title is a partnership in which the U.S. person owns directly or indirectly an interest in more than 50% of the partnership’s profits (distributive share of partnership income taking into account any special allocation agreement) or more than 50% of the partnership capital; (v) the owner of record or holder of legal title is a trust in which the U.S. person is the trust grantor and has an ownership interest in the trust for U.S. federal tax purposes; (vi) the owner of record or holder of legal title is a trust in which the U.S. person has a present beneficial interest, either directly or indirectly, in more than 50% of the assets of the trust or from which such person receives more than 50% of the trust’s current income for the calendar year; or (vii) the owner of record or holder of legal title is any other entity in which the U.S. person owns directly or indirectly more than 50% of the voting power, total value of equity interest or assets, or interest in profits.

A U.S. person has signature or other authority if the individual (either alone or in conjunction with someone else) has the authority to control the disposition of assets held in a foreign financial account through direct communication (written or oral) to the bank or other financial institution that maintains the account.

Form 5471 is used by U.S. persons involved in foreign corporations to satisfy federal reporting requirements under Internal Revenue Code (IRC) sections 6038 and 6046.

Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, is required to be filed by several categories of taxpayers.  These categories include the following:

• Category 1 – Shareholders of SFCs: S. shareholders owning at least 10% of the total combined voting power of all classes of stock in a specified foreign corporation(SFC). SFCs include (1) controlled foreign corporations (CFC), which are foreign corporations with U.S. shareholders that own at least 50% of the total combined voting power of all classes of its voting stock, or the total value of the stock of the corporation, and (2) foreign corporations whose domestic corporations have a U.S. shareholder. A passive foreign investment company that is not classified as a CFC will not be considered an SFC.
• Category 2 –Officers and Directors:  citizens or residents who are officers or directors of foreign corporations in which a U.S. person has acquired at least (1) 10% of the total value of the corporation’s stock, (2) 10% of the total combined voting power of all classes of stock with voting rights, or (3) an additional 10%, in value or voting power, of the outstanding stock of the foreign corporation. A U.S. person can be a citizen or resident, a domestic partnership, a domestic corporation, or an estate or trust.
• Category 3 –U. Persons Holding 10% of Stock: U.S. persons holding at least (1) 10% of the total value of the corporation’s stock, or (2) 10% of the total combined voting power of all classes of stock with voting rights. This 10% ownership requirement is met whether the 10% interest is acquired through multiple transactions or a single transaction. Relinquishing stock in order to fall below the 10% threshold will not remove a U.S. person from Category 3. A foreign person who holds this 10% interest in a foreign corporation and then becomes a U.S. person is included in Category 3.
• Category 4 –Controllers of a Foreign Corporation: S. persons who had control of a foreign corporation during the annual accounting period of the foreign corporation. A U.S. person meets the control requirement when at any point during the person’s tax year, the person owns stock in the foreign corporation possessing more than 50% of the total value of shares, or more than 50% of the total combined voting power of all classes of voting stock. A person who controls a corporation that, in turn, controls another corporation in the same manner is deemed to control the other corporation.
• Category 5 – Shareholders of CFCs: U.S. shareholders owning stock in a CFC. U.S. shareholders are U.S. persons holding at least 10% of (1) the total combined voting power of all classes of the CFC’s voting stock, or (2) the total combined voting power or value of shares of all classes of the CFC’s stock. U.S. shareholders also include U.S. persons that hold any stock of a CFC that also is a captive insurance company.

U.S. citizens and resident aliens living outside the United States are generally allowed the same deductions as citizens and residents living in the United States. Taxpayer who paid or accrued foreign taxes to a foreign country on foreign source income and are subject to U.S. tax on such income, may be entitled to take either a foreign tax credit on foreign income taxes or an itemized deduction for eligible foreign taxes.

Foreign pensions cannot be excluded on Form 2555.  Foreign earned income for purposes of the foreign earned income exclusion does not include pensions and annuity income (including Social Security benefits and railroad retirement benefits treated as Social Security).

The expatriation tax provisions apply to U.S. citizens who have relinquished their citizenship and to long-term permanent residents (green card holders) who have ended their U.S. residency. The Form 8854 is used by individuals who have expatriated to inform the IRS of their expatriation and certify they have complied with all federal tax obligations for the 5 tax years preceding the date of their expatriation.

Foreign persons are generally subject to U.S. withholding tax at a 30% rate on the gross amount of certain income they receive from U.S. sources. By providing a completed Form W-8 BEN, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding, to the U.S. payer (also known as the U.S. withholding agent) before or at the time income is paid or credited, a taxpayer:

Establishes that they are not a U.S. person,

Claims that they are the beneficial owner of the income for which Form W-8 BEN is being provided, and

If applicable, claim a reduced rate of, or exemption from, withholding as a resident of a foreign country with which the United States has an income tax treaty

Taxpayers who have a financial interest in or signature authority over a foreign financial account, including a bank account, brokerage account, mutual fund, trust, or other type of foreign financial account, the Bank Secrecy Act may be required to report the account yearly to the U.S. Internal Revenue Service (IRS) by filing FinCEN Report 114, Report of Foreign Bank and Financial Accounts (“FBAR”) (formerly TD F 90-22.1).

In addition, U.S. citizens and residents with specified foreign financial assets with an aggregate value exceeding $50,000 must report them to the IRS on Form 8938, Statement of Specified Foreign Financial Assets, attached to their federal income tax return.

The Form 8938 filing requirement does not replace or otherwise affect a taxpayer’s obligation to file FinCEN Report 114, Report of Foreign Bank and Financial Accounts (“FBAR”) (formerly TD F 90-22.1). For a comparison table of these two foreign account reporting requirements, see the Comparison of Form 8938 and FBAR Requirements.

Additional reporting requirements may apply.

An income tax treaty is an operative legal agreement between or among nations that coordinates, to some degree, the tax systems of each respective country that is a party to the treaty.  Article 2 of the Vienna Convention on the Law of Treaties provides that:

A treaty is an international agreement (in one or more instruments, whatever called) concluded between States and governed by international law.

Convention on the Law of Treaties, Vienna, 23 May 1969. While “tax treaties” are often named or referred to as “agreements” or “conventions,” the name given to the instrument is not particularly important.  It represents an agreement between or among sovereign countries with respect to the taxation of the income of their respective citizens and residents.  Treaties are generally intended to reduce or eliminate double taxation of income earned by residents of either country from sources within the other country and to prevent avoidance or evasion of the taxes of the two countries.

Tax treaties can be “bilateral” or “multilateral” agreements.  A bilateral treaty is an agreement directly between two countries, conferring rights and imposing obligations on the two contracting States.   There are currently more than 3,000 bilateral income tax treaties in effect across the globe.  The vast majority of those treaties are based upon two particularly influential model tax conventions: the United Nations and OECD Model Conventions.

Multilateral tax treaties are instruments or agreements among more than two countries, all mutually agreeing to the terms of the instrument.  While there have historically been relatively few multilateral income tax treaties, recent efforts by the OECD and its Base Erosion and Profit Shifting (“BEPS”)[1] project have seen multilateral instruments grow in prominence in the international tax context.

Treaties are built upon the principle of reciprocity.  Under Article 26 of the Vienna Convention, treaties are binding on the signatory countries.  Each country must, under the Convention, abide by and execute the treaty in good faith. This is known as the pacta-sunt-servanda principle—Latin for “agreements must be kept.”

The United States has income tax treaties with a number of foreign countries. Under these treaties, residents (not necessarily citizens) of foreign countries may be eligible to be taxed at a reduced rate or exempt from U.S. income taxes on certain items of income they receive from sources within the United States. These reduced rates and exemptions vary among countries and specific items of income.

Tax treaties generally reduce the U.S. taxes of residents of foreign countries as determined under the applicable treaties. With certain exceptions, they do not reduce the U.S. taxes of U.S. citizens or U.S. treaty residents. U.S. citizens and U.S. treaty residents are subject to U.S. income tax on their worldwide income.

Treaty provisions generally are reciprocal (apply to both treaty countries). Therefore, a U.S. citizen or U.S. treaty resident who receives income from a treaty country and who is subject to taxes imposed by foreign countries may be entitled to certain credits, deductions, exemptions, and reductions in the rate of taxes of those foreign countries. U.S. citizens residing in a foreign country may also be entitled to benefits under that country’s tax treaties with third countries.

The preferred tax treaty policies of the United States have been expressed from time to time in model treaties and agreements. The Organization for Economic Cooperation and Development (the “OECD”) also has published model tax treaties. In addition, the United Nations has published a model treaty for use between developed and developing countries. The Treasury Department, together with the State Department, is responsible for negotiating tax treaties. The United Nations has also published a model income tax treaty (“the U.N. model”).

If you are treated as a resident of a foreign country under a tax treaty, and not treated as a resident of the United States under a treaty (i.e., not a dual resident), a taxpayer is treated as a nonresident alien in figuring U.S. income tax. For purposes other than figuring tax, however, the IRS maintains that the taxpayer is treated as a U.S. resident. For example, the taxpayer may be required to file information reports with the IRS.

One of the primary purposes of a tax treaty is to reduce or eliminate double taxation on income from sources within one of the countries paid to a resident of the other country that is a party to the treaty.  The Mutual Agreement Procedure (“MAP”) article of U.S. income tax treaties is designed to facilitate the “competent authority” process.  Competent authority process refers to all steps in the process of initiating and resolving a competent authority case.

A Competent Authority Arrangement is a bilateral agreement between the United States and the treaty partner to clarify or interpret treaty provisions. Competent Authority Arrangements also exist between the United States Internal Revenue Service and each United States Territory and Commonwealth tax agency to address issues of interest to the respective jurisdictions.

Under most U.S. income tax treaties, a taxpayer must be a resident for treaty purposes (“treaty resident”), a national (as defined in the treaty), or a citizen of one of the Contracting States to the treaty to request competent authority assistance under that treaty. E.g., see U.S.- Canada Income Tax Treaty, Art. XXVI(1).

Notes that a person’s status as a “treaty resident” is separate from that person’s ! status as a resident under domestic tax law principles. A resident of a country for treaty purposes is a person who satisfies the requirements of the relevant treaty’s Resident article. E.g., see U.S. Model Treaty (2006), Art. 4.

The U.S. competent authority conducts the competent authority process through two offices: The Advance Pricing and Mutual Agreement Program (“APMA”) and the Treaty Assistance and Interpretation Team (“TAIT”).

The APMA has primary responsibility for cases arising under the business profits and associated enterprises articles of U.S. tax treaties.  For example, if an allocation made by the IRS pursuant to section 482 of the Internal Revenue Code would result in double taxation, the APMA has primary jurisdiction.

TAIT, on the other hand, has primary responsibility for cases arising under all other articles of U.S. tax treaties as well as cases arising under U.S. tax treaties with respect to estate and gift taxes.

Both APMA and TAIT are authorized to consider cases arising under the permanent establishment articles of U.S. tax treaties.

The concept of “transfer pricing” relates to the pricing of transactions between controlled entities. For example, when a US parent (Parent) sells a product to its controlled foreign corporation (CFC), I.R.C. section I.R.C. § 482 requires Parent to sell that product at an arm’s length price to its CFC. Under IRC  I.R.C. § 482, controlled entities should price transactions in the same way that uncontrolled entities would under similar circumstances. This is, in essence, the “arm’s length standard,”—the price of the product that Parent charges its CFC should be the same as it would charge to an unrelated party for the same product under similar circumstances.

If the transfer price is not arm’s length, I.R.C. § 482 provides the IRS with the authority to make adjustments by reallocating items of gross income, deductions, credits, or allowances in order to properly reflect income between the entities.

Section 482 allows the IRS to make adjustments and allocations in order to ensure that transactions clearly reflect income attributable to controlled transactions and to prevent the evasion of taxes.

The statutory language of section I.R.C. § 482 envisions three basic requirements before it applies:

1. Two or more organizations, trades or businesses;
2. common ownership or control, either directly or indirectly; and
3. An IRS determination that an allocation is necessary either to prevent evasion of taxes, or to clearly reflect the income of the entities.

Section 482 encompasses the so-called arm’s-length standard.  The arm’s-length standard applies to outbound and inbound transactions.

Under the U.S. model, one treaty country may not tax the business profits of an enterprise of a qualified resident of the other treaty country, unless the enterprise carries on business in the first country through a permanent establishment situated there. In that case, the business profits of the enterprise may be taxed in the first country on profits that are attributable to that permanent establishment. The U.S. model describes in detail the characteristics relevant to determine whether a place of business is a permanent establishment. The term includes a place of management, a branch, an office, a factory, a workshop, a mine, an oil or gas well, a quarry, or any other place of extraction of natural resources.

The U.S. model provides that the business profits to be attributed to the permanent establishment include only the profits derived from the assets or activities of the permanent establishment. The U.N. model adds a limited “force of attraction rule” which would allow the country in which the permanent establishment is located to attribute to the permanent establishment sales in that country of goods or merchandise of the same or similar kind as those sold through the permanent establishment, and to attribute to the permanent establishment other business activities carried on in that country of the same or similar kind as those effected through the permanent establishment.