1315. Trade or Business.

Generally, a foreigner is engaged in a U.S. trade or business if he performs personal services within the U.S. during the taxable year. However, this does not extend to personal services performed by a nonresident alien individual who is temporarily present in the U.S. for 90 days or less during the taxable year and whose compensation does not exceed $3,000 when his services are performed (1) for a nonresident alien individual, foreign partnership, or foreign corporation not engaged in a U.S. business, or (2) for a branch office maintained in a foreign country or U.S. possession by a U.S. citizen or resident or by a domestic partnership or corporation (Code Sec. 864 (b) (1)).8

A nonresident alien individual (or foreign corporation) who is not engaged in a U.S. trade or business but realizes income from investment real estate located in the U.S. may elect to treat the income from the property as income effectively connected with a U.S. business. In this way, he may offset the income from the property by the allowable income tax deductions attributable to such income (Code Secs. 871(d) and 882(d) ).o

1316. Trading in Securities.

Trading in stocks, securities, or commodities in the U.S. for one's own account, whether done personally or through a resident broker or agent (irrespective of whether the agent has discretionary authority to act), does not constitute the conduct of a U.S. trade or business by a nonresident alien individual or foreign corporation. This, however, does not apply to a dealer in stocks, securities, or commodities or to a foreign investment corporation if it has its principal office in the U.S. (Code Sec. 864 (b) (2) ).1o

1317. Income from U.S. Sources.

10

What is "income from sources within the United States" is determined by a set of technical rules (Code Sec. 861)." For example, all interest on U.S. bank deposits or deposits in a U.S. banking branch of a foreign corporation, interest paid on accounts with mutual savings banks, domestic building and loan associations and similar institutions, and interest on amounts held by insurance companies on deposit are treated as foreign source income (unless effectively connected with a U.S. business) and are free of tax when paid to a nonresident alien or foreign corporation. These exemptions, however, terminate after December 31, 1975.

1318. Deductions.

A nonresident alien individual or foreign corporation engaged in a U.S. trade or business is allowed to take income tax deductions to the extent that they are connected with income effectively connected with the U.S. trade or business, plus the deduction for charitable contributions. In addition, a nonresident alien individual may take a casualty or theft loss deduction on property located within the U.S. and the deduction for personal exemptions (in the case of an individual who is not a resident of Mexico or Canada or an American Samoan, only one exemption is allowed) (Code Secs. 873 and 882).12

1319. Foreign Tax Credit.

12

A nonresident alien individual or a foreign corporation engaged in a U.S. business is allowed a foreign tax credit for any foreign income, war profits, or excess profits tax paid or accrued on foreign income which is subject to U.S. tax. This applies to the three types of foreign source income which are treated and taxed as income effectively connected with a U.S. business under the rules discussed at 1312. The "per country" and "overall" limitations (see 1352) apply to this credit (Code Sec. 906).13

1320. Foreign Student or Exchange Visitor.

A nonresident alien individual who is not otherwsie engaged in a U.S. trade or or business and who is temporarily present in the U.S. as a nonimmigrant under Sec. 101 (a) (15) (F) or (J) of the Immigration and Nationality Act (relating to visiting students, teachers, trainees, etc.) is considered to be engaged in a References are to paragraphs of the 1973 Standard Federal Tax Reports.

8ག4131.

94133. 4174.

104131.

11 7 4101.

124156, 4174.

13 ¶ 4332A.

U.S. business. This means that any taxable portion of a scholarship or fellowship grant and expenses incidental thereto (see ¶850), to the extent derived from U.S. sources, are taxamle at the same rates (but subject only to a 14% withholding rate) applicable to a U.S. citizen. Payments received by these individuals from a foreign employer are fully exempt from tax. Also, a scholarship or a fellowship received by a foreign student or exchange visitor from a foreign government or from certain binational, multinational, and international organizations is exempt from tax, subject to the limitations described at ¶ 850 (Code Secs. 117, 871 (c), 872 (b) and 1441).14

1321. Foreign Ship or Aircraft.

An exemption from U.S. taxation is granted to earnings derived from the operation of ship or aircraft registered under the laws of a foreign country which grants an equivalent exemption to a U.S. citizen or domestic corporation (Code Sec. 883).15

1322. Expatriation to Avoid Income Tax.

Both the effectively connected income and any other U.S.-source income of an individual are taxed at regular U.S. rates if he lost his U.S. citizenship within 10 years of the taxable year in question (but after March 8, 1965) and if one of the principal purposes of the expatriation was the avoidance of U.S. income, estate, or gift taxes. This treatment, however, does not apply if it results in a smaller U.S. income tax than would otherwise be imposed (Code Sec. 877).16 1324. Alien Departing from the United States

Generally, no alien (whether resident or nonresident) is permitted to depart from the country unless he first obtains from the District Director a certificate that he has discharged his income tax liability. Advance payment of the tax is not required if the Treasury determines that tax collection will not be jeopardized by the alien's departure (Code Sec. 6851 (d)).19

1325. Pensions.

A nonresident alien who has worked for the United States only abroad will not usually have to pay a tax on his pension (Code. Sec. 402(a) (4)).20

1326. Returns.

A nonresident alien individual (other than one whose wages are subject to withholding) and a foreign corporation (other than one having an office or place of business in the U.S.) must file income tax returns on or before the 15th day of the 6th month following the close of their taxable year (Code Sec. 6072(c)).1 In other cases, returns are due at the same time applicable to a U.S. citizen or domestic corporation. A nonresident alien individual uses Form 1040NR.

1331. Foreign Tax Treaties.

FOREIGN TAX TREATIES

The United States has negotiated a network of treaties with other countries to avoid international double taxation and to prevent tax evasion. Provisions are included to prevent fradulent evasion and also to restrict legal avoidance. Principal tax treaties now in force are those with Australia, Austria, Belgium, Canada, Denmark, Finland, France, West Germany, Greece, Ireland, Italy, Japan, Luxembourg, the Netherlands, New Zealand, Norway, Pakistan, Sweden, Switzerland, Trinidad and Tobago, Union of South Africa, and the United Kingdom. Specific provisions in the law may be subordinate to provisions of these tax treaties (Code Sec. 894; Reg. § 1894-1), but United States law remains in effect in the absence of a specific treaty provision.

2

"CONTROLLED" CORPORATION

3319. U.S. Shareholder Taxed on Undistributed Earnings.

Certain controlled foreign corporations designed to obtain tax deferral for their shareholders are sometimes called "tax haven" corporations. Where a for

References are to paragraphs of the 1973 Standard Federal Tax Reports.

eign corporation (see ¶ 1345 for foreign personal holding companies) is controlled for an uninterrupted period of 30 or more days by U.S. shareholders, such shareholders are taxed on some of the corporation's undistributed earnings, as well as on its distributed earnings.

A U.S. shareholder is a U.S. person who actually or constructively owns 10% or more of a foreign corporation's voting interest. A "U.S. person" includes a U.S. citizen or resident, a domestic partnership, a domestic corporation, and an estate or trust (other than a foreign estate or trust whose income from sources without the U.S. is not includible in the beneficiaries' gross income). A controlled foreign corporation is one in which more than 50% of the voting interest is owned by U.S. shareholders on any day in the corporate tax year. However, a foreign insurance company is considered a controlled foreign corporation if 25% of its stock is owned by U.S. shareholders and the gross premiums with respect to insurance or reinsurance or annuity contracts on U.S. risk are more than 75% of the corporations gross premiums on all risks (Code Secs. 951, 957, and 958; Reg. 88 1.951-1, 1.957-4 and 7.958-1-1.958-2).3

A U.S. shareholder must include in his gross income his share of the corporation's (1) "subpart F income," (2) previously excluded "subpart F income" withdrawn from investment in less developed countries, and (3) the increase in earnings invested in U.S. property. "Subpart F income" is foreign base company income (foreign personal holding company income and foreign base company sales and services income) and income from the insurance of U.S. risks (Code Secs. 951-956; Reg. §§ 1.951-1-1.956-2). Income received by a controlled foreign corporation will not be included in its foreign base company income unless the corporation, or the transaction through which the income was derived, had a substantial reduction of income tax as one of its significant purposes."

The gross income items, above, are included only for the period during the year that the corporation was "controlled" by U.S. shareholders.

"Subpart F income" is not taxed to U.S. corporate shareholders if certain minimum distributions are made by the controlled foreign corporation. These minimum distribution requirements vary, depending upon the foreign tax rate applicable to the controlled corporation, and rules relating to an election to receive minimum distributions have been issued (Code Sec. 963; Reg. §§ 1.963–1— 1.963-7). Specific exceptions are also made for foreign export trade corporations, domestic international sales corporations and corporations created or organized in Puerto Rico and U.S. possessions (Code Secs. 957, 970-972, 991; Reg. §§ 1.957– 3, 1.957-4, 1.970-1-1.972-1).

8

An individual U.S. shareholder may elect to be taxed as a domestic corporation upon undistributed earnings of a controlled foreign corporation and thereby become eligible for foreign tax credit (Code Sec. 962; Reg. §§ 1.962-1-1.962-4). 1340. Returns.

An annual information return on Form 2952 must be made by every U.S. person (see [1339) who controls (more than 50% ownership of combined voting stock) a foreign corporation. If such a corporation, in turn, controls a subsidiary corporation, a return must be made for the subsidiary. Failure to file such return will result in a reduction of foreign tax credit (Code Sec. 6038; Reg. § 1.6038–2).o A U.S. shareholder of a controlled foreign corporation who owns stock in such corporation on the last day of a taxable year on which the corporation was a controlled foreign corporation must file a Form 3646-Income from Controlled Foreign Corporation with his return for the taxable year in which or with which the taxable year of the controlled foreign corporation ends.10

DISC

1341. Domestic International Sales Corporation.

For taxable years beginning after 1971, a domestic corporation whose income is predominantly (95%) derived from export sales and rentals may defer paying U.S. tax on up to 50% of that income. The other half is taxed directly to share

References are to paragraphs of the 1973 Standard Federal Tax Reports. 34380, 4380A, 4386-4387B.

443804385B.

54383F.02.

64392-4392G.

holders. A corporation entitled to this treatment is referred to as a Domestic International Sales Corporation (DISC). The tax deferred income is never taxed to the DISC. And it is taxed to the shareholders only when distributed, when a shareholder sells his stock, or when the corporation no longer qualifies as a DISC. The 50% of the DISC's income that is taxed directly to shareholders, certain other constructive distributions, and actual distributions to shareholders are treated as dividends (but, in the case of actual distributions, only to the extent that they exceed income previously taxed directly to shareholders). But these dividends are not eligible for the 85% or 100% intercorporate dividendsreceived deduction. Nor may a DISC join in filing a consolidated return. On the other hand, the dividends are treated as foreign source income and as received from a foreign corporation. Therefore, the shareholders are entitled to claim a Sec. 902 "deemed" foreign tax credit (¶ 1356) for taxes paid by a DISC to foreign countries (Code Secs. 992, 993 and 995).10

10a

A DISC typically will be a subsidiary of its parent manufacturing, etc., corporation. It may export as a principal, purchasing and reselling export property. Alternatively, it may act as a commission agent for export sales. In determining the taxable income of a DISC (up to 50% of which is not currently taxed), the usual inter-company pricing rules of Sec. 482 are relaxed. Thus, for example, sales by a manufacturing parent to its DISC export subsidiary need not be at arm's length if the price charged is within specified "safe harbors." Similar rules apply to commissions and rentals. (Code Sec. 994.) 10b

For a corporation to qualify as a DISC, it must meet the following requirements: (1) at least 95% of its gross receipts must be export receipts: (2) at least 95% of its assets must be export assets; (3) it must not have more than one class of stock; (4) it must have a minimum capital (par or stated value) of at least $2,500 on each day of its taxable year; and (5) it must make an election (Code Sec. 992(a) (1)).1

10c

An election is made on Form 4876 and must be consented to by each person who is a shareholder on the first day of the corporation's first taxable year as a DISC. Persons who become shareholders at a later date need not consent, nor is the election jeopardized by their failure to do so. The election must generally be filed within the 90-day period preceding the corporation's first taxable year as a DISC. For new corporations organized in 1972, however, the election could be made within 90 days following the beginning of the first taxable year. Shareholder consents must be filed within 90 days following the beginning of the first taxable year, but the Commissioner has the power to grant extensions of time for reasonable cause (Code Sec. 992(b); Rev. Proc. 72–12).10

A DISC is required to file an annual information return (Form 1120 DISC), due on or before the 15th day of the 9th month following the end of its taxable year (Code Sec. 6011(e) and 6072(b)).10

FOREIGN PERSONAL HOLDING COMPANY

1345. Foreign Personal Holding Company.

A United States shareholder is subject to tax on undistributed income, as well as on distributed income, of a foreign personal holding company (Code Sec. 551; Reg. § 1.551-1)." The tax on undistributed income is imposed only on a shareholder who is a U.S. citizen or resident, a domestic corporation, a domestic partnership, or a domestic estate or trust, as though the income had been actually distributed as dividends.

A foreign corporation is usually classified as a foreign personal holding company if

(a) at least 60% (50% after the first taxable year) of its gross income (not gross receipts) consists of dividends, interest (whether or not treated as rent), royalties (whether or not mineral, oil or gas royalties), annuities, rents (unless amounting to 50% or more of gross income), gains in stock and commodity transactions, income from personal service contracts and other specified types of income; and

References are to paragraphs of the 1973 Standard Federal Tax Reports. 10a4399F, 4399J, 4399P.

10b 4399M.

10c4399F.

10d 4399F, 4399HH.30.

te 5005. 5129.

113349, 3350.

(b) more than 50% in value of its outstanding stock is owned directly or indirectly by five or fewer U.S. citizens or residents (Code Secs. 552 and 553; Reg. §§ 1.552-2,1.552-3 and 1.553-1).12

1346. Returns.

A U.S. citizen or resident who is an officer or director of a foreign holding company or who is a stockholder owning 50% or more in value of the outstanding stock of such company must file an annual return on Form 957 with information on the ownership of stock or convertible debentures. However, duplicate returns are not required for an individual who is both a shareholder and an officer or director. In addition, a U.S. citizen or resident who is an officer or director of the company must file an annual return on Form 958 with information as to the income of the company (Code Sec. 6035; Reg. §§ 1.6035-1 and 1.6035-2).13

FOREIGN TAX DEDUCTION AND CREDIT

1351. Deductions and Credits.

A United States citizen may deduct foreign income tax he has paid or accrued, or he may apply the foreign tax as a credit against his U.S. income tax. A domestic corporation has the same alternative. (Code Secs. 901-905.) 11

Code Sec. 265 expressly disallows deductions allocable to income which is "wholly exempt." Also, if a taxpayer's foreign earned income is exempt by virtue of the exclusion in Code Sec. 911 (a) (see ¶ 1301), Code Sec. 911 precludes a deduction for the foreign tax. However, the above sections do not preclude a deduction for foreign tax paid on income which is subject to U.S. tax.

If a taxpayer chooses a credit against tax for any taxable year, then no deduction for any foreign tax for that year may be taken against United States income (Code Sec. 275(a) (4); Reg. § 1.164-2)." Nor can a taxpayer take a credit for some foreign taxes and a deduction for others in one taxable year. A taxpayer can, however, change from deduction to credit (or vice versa) in different taxable years and may make such a change in the taxable year at any time within the refund limitation period.

16

A taxpayer who takes a deduction for foreign taxes paid may file a claim to take a credit in lieu of the deduction within 3 years from the time the return was filed or 2 years from the time the tax was paid, whichever period expires later.1 An individual may not deduct or credit foreign items if he elects the "standard" deduction or the Optional Tax Tables (Code Sec. 36).10

16a

The credit for foreign tax may be taken for income or profits taxes imposed by a foreign country or a U.S. possession upon a domestic corporation or a U.S. citizen, whether resident or nonresident (or imposed by a U.S. possession upon a U.S. resident), and paid or accrued during the taxable year. The credit applies against U.S. income tax liability (Code Sec. 903; Reg. § 1.903–1).1

An alien resident of the U.S. or a resident of Puerto Rico for the entire taxable year may credit taxes paid or accrued to any U.S. possession.

A resident alian or a bona fide resident of Puerto Rico during the entire taxable year is allowed a credit for such a tax assessed by any foreign country, only if the country of which he is a citizen or subject in imposing such taxes allows a like credit to citizens of the United States residing in such country (Code Sec. 901 (b) (3), Reg. § 1.901-1).1

18

A nonresident alien individual or foreign corporation is eligible for foreign tax credit as noted at ¶ 1319.

1352. Limitations.

In computing the amount of the "credit against the tax" on account of foreign taxes, two alternative limitations must be considered. One is called the "per country" limitation; the other is known as the "overall" limitation. Taxable income for the purpose of either method is computed, in the case of individuals, without deducting personal exemptions. Under the "per country" method, the credit is computed separately for foreign taxes paid to each country. The credit

References are to paragraphs of the 1973 Standard Federal Tax Reports.