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Taxing Foreign Corporations in the Digital Age

Effectively Connected Income and it’s Tax Consequences

Taxing Foreign CorporationsForeign entities that deliver digital goods and services using the internet as a point of distribution may be subject to U.S. income tax. The nature and character of the goods and services will dictate how the income is taxed. In the interest of clarity, the following discussion is limited to effectively connected income.

The explosion of foreign companies using the internet to deliver digital products and services has afforded foreign businesses the opportunity to compete in global markets without the necessity of a traditional bricks and mortar operation. In this regard, the critical question is always this: Does the United States have a right to impose an income tax? It is important to note that jurisdiction to tax a foreign entity requires determining whether a sufficient connection or nexus with the United States exists to justify imposing an income tax. Foreign corporations are subject to U.S. income tax on income that is considered effectively connected income (“ECI”) and associated with conducting a trade or business within the United States 26 U.S.C. § 864(b), 26 U.S.C. § 871(b) and26 U.S.C. § 882(a).

Business Presence in United States Tax Consideration

ECI is based upon the permanent establishment of a presence in the United States. In some cases, the question of permanent establishment is easy. For instance, a foreign company that leases office space and employs its administrative staff in Phoenix will be deemed to have permanently established a U.S. presence. Other cases are less clear, for example, a case where goods and services are digitally delivered to consumers in the United States, while the company’s operation, employees, website and servers are located in one or more countries. Generally, the existence of a website alone is insufficient to establish a permanent establishment within the United States due to the absence of any tangible physical component. In contrast, the location of the server, where the website is hosted is a piece of equipment with a physical location. Thus, the presence of a server in the United States may be sufficient for purposes of permanently establishing a U.S. presence. This is particularly true where a foreign company owns and operates its servers or has physical access to them. For U.S. tax purposes, the delivery of goods and services through a server that is located in the United States but neither owned, leased nor at the disposal of a nonresident does not currently create a permanent establishment in the United States.

Foreign companies will often deliver their products and services via the Cloud using the Software as a Service(“SaaS”) model or by using a CD, portable USB device or by the customer downloading a copy of the software from the company’s website. The SaaS model involves using a third party to host a foreign company’s website and software and to store and process its hardware infrastructure. These solutions are generally delivered to consumers over the internet for a fee. The manner in which these products and services are delivered will affect how the income is characterized for U.S. tax purposes.

Character of Income in US Business Tax Consideration

The amount of a foreign company’s ECI depends, in part, on the source and character of the income.The starting point for evaluating these inbound transactions can be found in the Treasury Software Regulations(the “Regs.”). Under the Regs, the character of payments received in transactions involving computer programs is based on the nature of the rights conveyed. The determination is made without regard to the transaction form adopted by the parties or the terms they apply (26 C.F.R. § 1.861-18(g) (1)). Moreover, the means of the transaction (that is, whether by purchase of physical disc or electronic download) is irrelevant (26 C.F.R. § 1.861-18(g) (2)).

Under the Regs, computer software transactions are classified into four categories:

  • The sale of a copyright right: the right to make copies of the property, the right to prepare derivative property, the right to make public performances, or the right to publicly display the property (26 C.F.R. 1.861-18(c) (1) (i) and 26 C.F.R. § 1.861-18(c) (2) (i)-(iv)).
  • The license of a copyright right: considered a sale or exchange for income tax purposes if under the facts and circumstances, the transferee receives substantially all of the right to the underlying copyright. Where less than substantially all of the rights to the underlying copyright are transferred, the transfer will be treated as a license (26 C.F.R. §1.861-18(f) (1)).
  • The sale of a copyrighted article: transferee receives a copy of a software program but acquires no rights (or a deminimis grant of rights) that accompany a copyright right (26 C.F.R. § 1.861-18(c) (1) (ii)). To qualify for sale treatment, the transferee of the copyrighted article must receive all the “benefits and burdens” of ownership
  • The lease of a copyrighted article: Where all of the benefits and burdens of ownership have not been transferred, the transaction will be treated as a lease generating rental income (26 C.F.R. § 1.861-18(f) (2)).

The Regs, however, do not applyto transactions involving digitized content or services that do not involve the transfer of a computer program. Transactions involving hosted software, such as SaaS, do not include a transfer of a computer program, and, as such, are not subject to the Regs (26 C.F.R. §1.861-18(b) (1)). The question then is: whether hosted software transaction is a property or services transaction? That distinction can be found in 26 U.S.C. §7701(e),which provides that a contract that “purports to be a service contract” can be recast as a lease based upon the existence of the following factors:

  • The customer is not in physical possession of the software.
  • The customer does not control the software application.
  • The customer does not have a significant economic or possessory interest in the software.
  • The provider uses the software to provide services to multiple third parties.

The Section 7701 (e) factors should be carefully examined when considering SaaS services or similar digital transactions. Payments made in exchange for SaaS services are generally characterized as service income because such transactions do not satisfy a number of the Section 7701(e)factors.

In Tidewater Inc. v. U.S.,(565 F.3d 299 (5th Cir. 2009), the U.S. Court of Appeals for the 5th Circuit applied the 26 U.S.C. § 7701(e) factors in holding that income earned by a time charter that supplied a vessel complete with a crew to its customers constituted leasing income.In Xerox Corp. v. U.S., (656 F.2d 659 (Ct. Cl. 1981), the U.S. Court of Claims applying a set of factors predating Section 7701(e) determined that a supply of copying machines was treated as a service.

Source of income in US Business Tax Determination

In addition to the “character” of the income”, the “source” of the income will also drive certain U.S. federal income tax consequences (e.g., application of withholding tax to foreign persons, application of the foreign tax credit limitation formula).

Income earned from the performance of “services” is sourced according to the place of performance. If the services are performed in the United States, the income is U.S. sourced income, and subject to U.S. federal income tax; if the services are performed outside the United States, the income is considered foreign-sourced income and exempt from U.S. tax.

Determining where a digital service is performed, and, thus, the source of the income derived in connection with such service, can be difficult in certain cases. For instance, in Piedras Negras Broad Co. v. Comm’r,the United States Board of Tax Appeals held that the source of a Mexican broadcaster’s income was Mexico since the broadcast originated in Mexico and the facilities and personnel were located in Mexico, not the United States, where its customers were located ((43 BTA 297 (1941) (nonacq. 1941-1 CB 18), aff’d, 127 F.2d 260 (5th Cir. 1942)). Similarly, in  Korfund v. Comm’r,(1 T.C. 1180 (1943), the Tax Court interpretingPiedras Negrasheld that the source of such income was not within the United States, by holding that the source of income is the situs of the income-producing service and that the source of the income was the act of transmission.

In conclusion, tax jurisdiction as well as the character and source of incomeplay a critical role in determining the U.S. federal income tax consequences as well as how the income will be taxed. Accordingly, foreign companies planning to do business within the U.S. would be well advised to consult with an experienced and knowledgeable tax attorney prior to conducting business.

 

 

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Tax Relief for Expats who Renounce U.S. Citizenship

Relief Procedures for former U.S. Citizens

Tax relief for renouncing citizenship 1The new procedures attempt to address problems faced by some U.S. citizens, whose only connection with the United States is that they were born in America. Many of these individuals have been living overseas since an early age, and in some cases, are also citizens of the foreign country in which they reside.

The new procedures are aimed at providing relief to these former citizens who have had to deal with the problems associated with FATCA and other U.S. tax and reporting obligations. In case of FATCA, many foreign financial institutions have elected to close the accounts of U.S. expats rather than deal with the onerous compliance requirements and the 30% withholding obligations.

Consequently, expats have found banking overseas difficult if not impossible. In response to the problem, some have decided to renounce their U.S. Citizenship after determining that the benefits of U.S. Citizenship were outweighed by the problems FATCA and other U.S. tax and financial reporting requirements have created. Prior to the announcement, however, these expats were still expected to pay income tax on money they previously earned. The new Procedures address this concern.

Eligibility criteria and requirements under the Relief Procedures

Under the new procedures, eligible Individuals include those who relinquished their U.S. citizenship any time after March 18, 2010, the year FATCA was enacted and who also meet the following criteria:

  1. The Taxpayer has failed to file U.S. tax returns;
  2. The Taxpayer owes a limited amount of back taxes to the U.S. government ($25,000 in the past six years);
  3. The Taxpayer has net assets of less than $2 million; and
  4. Any prior U.S. compliance failure with the IRS was not due to willful conduct.

It is important to note that the procedures are only available to individuals. This means that estates, trusts, corporations, partnerships and other entities can’t use the procedures.

Those who are eligible are required to file outstanding U.S. tax returns, including all required schedules and information returns for the five years preceding and their year of expatriation. If the total tax for the six years period is less than $25,000, the taxpayer is relieved from paying U.S. taxes. Individuals who qualify for the procedures won’t be assessed penalties and interest.

Despite the relief the new procedures provide for U.S. citizens, the IRS cautions citizens regarding the permanent nature and consequences associated with relinquishing U.S. citizenship:

 “Relinquishing U.S. citizenship and the tax consequences that follow are serious matters that involve irrevocable decisions,” said the IRS. “Taxpayers who relinquish citizenship without complying with their U.S. tax obligations are subject to the significant tax consequences of the U.S. expatriation tax regime. Taxpayers interested in these procedures should read all the materials carefully, including the FAQs, and consider consulting legal counsel before making any decisions.”

The decision to relinquish one’s U.S. citizenship requires a careful evaluation of both quantitative and qualitative factors including income tax consequences, quality of life and mobility. In addition, any such decision needs to be evaluated in the context of political risk. Therefore, it is advisable that those who are contemplating renouncing their U.S. citizenship should consult with an experienced tax attorney who is familiar with the process, as well as the risks.

 

 

 

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The Liberal Elites: The Real Reason Why They Will Never Leave the USA

Why the Liberal Elites Will Never Leave the USA Despite Claiming Otherwise

5th amendment fbar tax for celebrities that want to expatriate now that Donald Trump has been elected President of the United States of America

With the presidential election in our rear view mirror, we are now able to turn our attention to those in the entertainment industry — and their veiled threats of leaving the United States.

Many of the liberal elite have threatened to leave the United States in the event of a Trump victory.

 I say that they are bluffing.

In truth, these entertainers have enlisted the assistance of the liberal media as an excuse for more face time and for them to remain relevant as “celebrities”.  Late night talk show hosts have also jumped in, as well as mainstream pundits.

Despite Trump’s resounding victory, liberal elites continue their rants of “racist” “homophobe,”“sexist,” “islamophobe, and “xenophobe” as well as the absurd assertion that Clinton should have been anointed the first woman President since she carried the popular vote. Please see the United States Constitution!

Hilary’s epitaph should now read:

“To me, being a gangster was better than being the president of the United States.” Henry Hill: “Goodfellas” 1990.

If history teaches us anything about entertainers, bombastic statements are rarely, if ever, followed up with any meaningful action. While Rosie, Miley, Amy, Whoopi, Chelsea, Samuel, Brian, Al, and others, publicly excoriated the President Elect throughout his campaign, vowing to leave the United States in the event of a Trump victory, it would appear these declarations were nothing more than veiled threats designed to influence the outcome of the election and enhance the respective entertainer’s stock.

The following examples show just how desperate and disingenuous these pseudo intellectuals are and also demonstrate the liberal elite’s penchant to evasively pivot when responding to a simple question that requires an honest answer.

  • Whoopi Goldberg  recently walked back her threat to leave the United States by stating on the View that I’m not leaving the country I was born and raised in,’ The cryptic statement, however, fails to answer the  question: Whoopi, why are you still here?
  • Likewise, Miley Cyrus recanted her promise to leave the country the morning after the election by treating us to a teary eyed emotional video where she conceded the election results and accepted Trump as her President. Like Whoopi, Miley has offered no explanation why she is still here.
  • After being called out on her promise to leave, Amy Schumer offered up a lame excuse in an Instagram statement that the threat of leaving was just a ‘joke.’ Despite dubious explanation, Schumer could not resist the “pivot” by attacking Trump supporters with the following rant: ‘Anyone saying pack your bags is just as disgusting as anyone who voted for this racist homophobic openly disrespectful woman abuser.’

My favorite and perhaps the most creative non-responsive answer came from Samuel L. Jackson.

  • After referring to Trump as a ‘motherf****r’ during a skit on the Jimmy Kimmel show, Jackson threatened to move to South Africa if Trump was elected. However, Jackson later announced via twitter that he is staying, but not without first expressing his indignation for those pressing him for an answer. Jackson said ‘When you learn the difference between My Actual Opinion and A Kimmel Skit….. Maybe we can talk. Till then, I’m Barbed Wire Up Your Asses!! [sic].’  Jackson also seized the moment to Pearl Harbor Trump and his supporters comparing Trump’s victory to the introduction of the Jim Crow laws, which enforced segregation: ‘The Last Time I survived Jim Crow I was Poor.’ He then added: ‘Guess what Motherf*****S.. Not This Time!! Enjoy your newfound win, Bigly!!’
  • Chelsea Handler offered a more civil, but equally disingenuous explanation on her Netflix Show as to why she will not be leaving the United States by stating: ‘ It’s easy to throw in the towel and say that we’re going to leave, or I’m gonna move to Spain.’ She added: ‘Because I want to move to Spain, I really, really want to move to Spain right now. But everyone in my office is like, “you have a responsibility. You have a voice, you need to use it and you have to be here.”’Chelsea, you still haven’t answered the question. Why are you still here?

There are also others who have threatened to leave in the event of a Trump victory.

Like their colleagues, these entertainers have failed to explain why they are still in the United States, instead electing to pivot.

  • Singer Cher, who threatened to move to the Planet Jupiter, has yet to address the question of why she is still living in the United States. Instead, Cher, who has not had a lucid thought since her divorce to the late Sonny Bono, provided her flock via social media with the following words of wisdom: ‘The world will never be the same. I feel sad for the young. [Trump] will never be more than the toilet; I’ve used as a symbol 4 Him. U Can’t Polish [a t***].’

The preceding examples illustrate the hypocrisy behind the liberal mantra: “When they go low, we go high.”  This list is by no means complete, but just a sampling.

The lame excuses as well as the assault on those who dare disagree with these traitors and other dilatory tactics make one thing clear. The liberal elites will never provide us with an honest answer as to why they will not leave. But do not despair. The real answer may be found in the provisions of the Internal Revenue Code and the application of the Exit Tax.

Here is how it works. For purposes of this discussion we will assume expatriation takes place in the year 2016.

A U.S. citizen who renounces her citizenship or a long term resident who terminates her U.S. resident status may be subject to what is sometimes referred to as an “Exit Tax.”  The Exit Tax only applies to “Covered Expatriates.”

For 2016, an individual is considered to be a Covered Expatriate if any of the following apply:

  1. Your average annual net income tax for the preceding 5 tax years ending before the date of expatriation or termination of residency is more than a specified amount adjusted for inflation. (For 2016 the average annual net income tax amount is $161,000);
  2. Your net worth is $2 million or more on the date of expatriation or termination of long term resident status; or
  3. You fail to certify on Form 8854 that you have complied with all U.S. federal tax obligations for the five years preceding the date of your expatriation or termination of your residence.

Based upon the above criteria and Celebrity Net Worth, the celebrities mentioned in this discussion would be considered Covered Expatriates.

If an individual is considered a Covered Expatriate, that individual is subject to income tax on the net unrealized gain from the sale of the individual’s property.

The IRS treats all property owned by a U.S. citizen or long term resident as if the property was sold at its fair market value on the day before expatriation. In other words the individual is taxed on the market to market net gain of all his or her assets.

The total amount of gain is reduced by an exclusion amount which is adjusted for inflation. For 2016 the exclusion is $693,000. The net gain, after allowance for the exclusion,is subject to income tax at the capital gains rate of 20% plus an additional 3.8% surtax. This rate is based upon the assumption that the Covered Expatriate is subject to the top tax bracket of 39.6%.

To illustrate how the Exit Tax is applied, consider the following example:

John, a famous Hollywood actor and producer, is considered a Covered Expatriate.  During a radio interview with ABC news on September 12, 2016 John threatens he will leave the country if that “asshole” Trump is elected. John follows through on his threat. On November 13, 2016 John renounces his U.S. citizenship. The fair market value of all property owned by John immediately preceding his expatriation is $75 million. John’s basis in the property is $25 million. The IRS will treat John’s property as if sold on the day before expatriation. The net unrealized gain on the “deemed” sale is $50 million. After allowance for the $693,000 exclusion, the net gain recognized for tax purposes is $49,307,000.Since John is in the top tax bracket of 39.6%, he would be subject to a capital gains rate of 20% and an additional 3.8% surtax. As such, John would owe $11,735,066.At first blush, a tax of 23.8% may seem a small price to pay in order to be free of Trump’s despotic rule, provided the assets are liquid. In this case, however, John’s assets primarily consist of non-liquid assets, such as real estate, luxury automobiles, a personal jet, two yachts, and a collection of antique cars. A “deemed sale” of these assets results in a cash crisis, causing John to “fire sale” his Ferrari, private jet, 2 yachts and his mountain home in Steamboat Springs, Colorado in order to satisfy the Exit Tax.

The above example provides insight as to why U.S. entertainers will never leave the states.

I would be remiss if I did not mention Al Sharpton. No A-List of celebrities would be complete without him. For those of you who are saddened at the prospect of Al Sharpton expatriating, you can relax. Mr. Sharpton is not going anywhere.  Al Sharpton, considered by some to be a serial tax evader, would be considered a Covered Expatriate based upon his reported net worth of $5 million. Furthermore, Mr. Sharpton’s unpaid federal income and employment taxes are substantial and well chronicled. There is no indication, at least in the foreseeable future that he will pay up.While Obama has been able to provide cover and insulate Sharpton from IRS Collections for the past eight years, the situation has now changed.  “Just Keepen’ It Real.”  Now back to Sharpton as a Covered Expatriate.

Since Certification is an integral part of the expatriation process, “Big Al” or Al “Slim Shady” Sharpton as he is affectionately referred to by radio talk show host, Curtis Sliwa, is currently unable to Certify on Form 8854 that he has complied with all U.S. tax obligations for the preceding five years. Slim Shady has two choices. He can pay his back taxes as well as the Exit Tax and Certify on Form 8854 that he is in compliance, at which point he would be free to leave the U.S. The alternative would be for him to falsely Certify on Form 8854 that he is in compliance and move to a non-extradition country. The latter alternative, however, may be foreclosed if Sharpton’s passport is revoked in accordance with Section 7345 of the Internal Revenue Code.  To date, no response. Cat got your tongue Al?

Finally, I’m a “little bit” disappointed that De Niro has yet to depart for Italy as rumored. Bob’s October 8, 2016 video rant has many in the public concerned. This Goodfella seems to have come unhinged.  Nevertheless, we still do not have an answer. Bob, why are you still here?

The liberal elites would have you think that they are selfless and concerned with championing the causes of those who are less fortunate and converting the masses who voted for Trump. These charlatans would also have you believe that they are concerned with the equitable treatment of all and the redistribution of wealth.  Unfortunately, they are not interested in redistributing their wealth nor are they interested in paying the “vig” in order to leave the States.

While it’s unfortunate that we are stuck with these hypocrites, at least for the foreseeable future, the public can take solace in knowing the real reason why we are unable to rid ourselves of these Hollywood elites. It’s the Exit Tax.

Serious about leaving?  Put up or shut up!

© 2016 Anthony N. Verni, Attorney at Law, Certified Public Accountant

Wednesday, November 16, 2016

 

 

 

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Expatriate Tax Advice: What Are the Filing Requirements for U.S. Expats?

What U.S. Expats Need to Know About IRS Filing Requirements
expatriate tax advice

Many expatriates have questions about how to handle their taxes while living abroad. There are many things to consider such as: Do I have to file U.S. income tax return? What about state taxes? And what if any income taxes can I deduct? 

The U.S. tax code can be complicated and confusing for expatriates. It is always best to consult an experienced tax attorney to reduce your tax burden and to also help you understand your rights and responsibilities.

It is important to understand that no matter where you live in the world, as a United States Citizen or a Permanent Legal Resident you are required to file an annual return with the Internal Revenue Service (IRS) if you meet the minimum income requirements. In 2014, the minimum income requirement for a single person less than 65 years of age was $10,150. A married couple both under 65, filing jointly, faced a minimum income requirement of $20,300. The United States does have treaties with several countries that may reduce the total amount you owe.

When it comes to U.S. state tax returns each state sets its own rules. The rules can be complicated and it is best to consult a professional when it comes to filing state returns. States like California, New Mexico, Virginia, and South Carolina have very strict rules when it comes to filing state returns after moving abroad.

Filing Requirements for U.S. Expats

Another area of confusion for expatriates is whether their income might qualify for the Foreign Earned Income Exclusion (FEIE). The IRS qualifies you as eligible for the Foreign Earned Income Exclusion (FEIE) if you fall into one of three categories:

  1. You are citizen of the US who qualifies as a bona fide resident of another country for a period of time containing one entire tax year.
  2. You are a resident alien of the US whose home country has an income tax treaty with the US. Additionally, you must be a bona fide resident of another country for a period of time containing one entire tax year.
  3. You are a citizen or resident alien of the US whose physical absence from the US constitutes a minimum of 330 days out of any 365.

There may also be deductions for any taxes you have paid to your country of residence.

As with any matter involving the U.S. Tax Code there are many pitfalls to trying to figure out what you can legally deduct from your income and how you can minimize your risks of an audit. It is best to consult an experienced tax attorney before filing your taxes. A consultation will help reduce your risk of mistakes on your tax returns and avoid costly audits.

 

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