International Taxation in America presents the most complete and indispensible guide to international taxation available in today's market. Author Brian Dooley, CPA, is a seasoned tax researcher and specialist in international tax and is among the very few experts who have experienced hundreds of international tax audits without a loss.
Covering international taxation for businesses, the taxation of shareholders of foreign corporations, foreign tax credits, cross-border estate planning, and much more, Dooley offers meticulous research and clear explanations of hundreds of international tax-related issues. Whether the subject is tax haven corporations and trusts, reducing taxes through tax treaties, learning how Americans are taxed abroad, or estate planning for multi-national families, Dooley explains the subject in thorough and clear language.
International Taxation in America provides valuable lessons for your enrichment, including useful links to help guide you online. You'll receive the level of information and expertise required to avoid mistakes and IRS scrutiny.
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International Taxation in America
By Brian Dooley
AuthorHouseCopyright © 2011 Brian Dooley, CPA. MBT
All right reserved.
Chapter OneForeign Trusts in America
We all have heard people say that things are not what they used to be. In American business, this is particularly true. In 1910, electricity was not in the White House. Cars were laughed at, with jokes like, "Get a horse!" Phones were rare, and there was no air travel. If you were born in 1900, then you were thirty-nine years old when we began using the tax code we still have today—the 1939 tax code. The tax-planning chapter of this book revolves around a major flaw in American tax law caused by the speed of change.
Most of the congressmen who wrote the 1939 tax code were born before 1900. Their view of the world was what you see in many silent movies ... and so was their tax law.
As I write this page today, May 6, 2010, the newspaper headlines are blaming a computer for the Dow's "flash crash" of a thousand points in one hour: "Computers, Not Human Error, Likely Caused Market Meltdown." Sounds like the movie 2001: A Space Odyssey and Hal the computer!
President Kennedy's tax reform in 1962 saw the biggest change for international taxation, with the enactment of the controlled foreign corporation law and the repeal of the force of attraction concept that changed the sourcing rules in American tax law. However, the concepts from 1939 remain intact.
In this book, you will experience my belief in the writings of Alvin Toffler regarding economic times, which he calls the first wave, the second wave, and now the third wave. In 5000 BC, we saw the start of the first wave. At that time, the tax collectors were biblical villains. Because few individuals had money, they paid taxes "in kind," or with commodity money. The second wave, the industrial revolution, saw the birth of income taxes, with the payment of taxes by paper money. In the late 1990s, the third wave economy created wealth in the developed world, while the second wave economy moved to Asia. Recently some businesses have started to accept only digital money (credit cards, debit cards, online banking payments, etc.) and will not accept paper money.
While this book covers all aspects of American international taxation and tax planning, it highlights the tax savings created by Congress with its decision to apply industrial age tax laws for a third wave economy.
With third wave tax planning, you will learn:
1. How to use a foreign trust to save income taxes 2. How Congress created a virtual foreign country for your trust's tax situs 3. How Congress created a virtual domestic corporation to be used as a tax haven corporation 4. How to pay your virtual computer for foreign machine services
The Best Foreign Trust Court Case
The best court case to guide you with tax planning for service income earned in a foreign country is the Nat King Cole case. Nat King Cole and his wife formed two foreign trusts, which in turn owned two tax haven corporations—PMSA and Associated Arts. PMSA was used for his foreign tours; Associated Arts (AA) was used for his music's copyright and master recordings (which are similar, in concept, to software). Music was sold as tangible property (there were no MP3s or iTunes); however, music was kept on a medium that would be akin to firmware in today's world.
Nat beat the IRS on the assignment of income doctrine for his personal performances. Nat also beat the IRS on Section 482 (arm's-length pricing). When he passed away, the assets in his foreign trust were excluded from his taxable estate.
In this chapter, you will read references to a domestic foreign trust. American tax laws have two types of foreign trusts. A trust with a foreign trustee and is governed by foreign law is a foreign trust. A trust with a domestic trustee, governed by domestic law and which has a flee clause, is a domestic foreign trust. A flee clause requires the trust to move if any person attempts to seize the trust assets. A flee clause is an asset protection trust. Chapter Six discusses cross-border estate planning and explores flee clauses. To read the IRS regulation on the use of the flee clause (which the IRS names auto migration), please click on this link.
Just how long should you expect these loopholes to exist? Looking at the government's approach to foreign trust provides an insight. The effective date for the current law was 1974. A quarter of a century later, in 2000, the IRS issued new regulations, which created a loophole.
Tax planning involving an absence of law requires searching the past one hundred years of court cases to obtain precedence.
Three Unique Second Wave Court Cases Apply to Today's Third Wave World
Tax case law for the third wave economy has not occurred. However, there are three second wave–era court cases that have third wave traits. These cases provide the design for third wave tax law.
First, a 1930s tax dispute determined that a Mexican radio station run out of Texas had tax-free foreign source income. From this case, we learn that the source of income from a computer hosted in a foreign country providing business service to American customers is foreign source income.
Second, Nat King Cole's offshore tax planning for his domestic song royalties and foreign touring income gets an A+ by the tax court. From this case, we learn the ideal foreign business structure.
Lastly, Xerox rocked the IRS when a court ruled that income earned by its copiers was machine service income, which was to be sourced where the service computer was located. From this case, we learn that a machine can provide "personal service income." Today many devices provide personal services to us, such as a GPS navigation system and the Rosetta Stone language learning software.
Piedras Negras Broadcasting Co., and/or Cia Radio Difusora De Piedras Negras, S.A. v. Commissioner of Internal Revenue (43 BTA) involves the beginning of the third wave commerce. Until the advent of radio and music on records, entertainment and news were in the form of hard copy or live performances. Radio was the sole entertainment that could not be purchase as tangible property.
The setting is the late 1930s. An American radio station moved to Mexico to serve its American audience. Compania Radio Difusora de Piedras Negras, SA, (the English translation of which is "Piedras Negras Broadcasting Company") was organized under the state of Coahuila, Republic of Mexico. Piedras Negras, Mexico, and Eagle Pass, Texas, are separated only by the Rio Grande River.
In 1936 and 1937, the radio station deposited $72,204.14 and $66,985.11 of its advertising income in its bank located in Texas. The IRS assessed the radio station taxes, claiming it was American source business income.
W. E. Branch, president of the radio station in 1936 and 1937, registered The Radio Service Co. in the assumed name records of Maverick County, Texas. Some contracts were entered in its name, which was used in connection with the business of the Piedras Negras Broadcasting Co. because of the difficulties Americans had in saying the name Piedras Negras.
Each day, employees of the radio station met in Eagle Pass, Texas, with the advertisers at the Hotel Eagle. The hotel furnished the radio station with a private meeting room. The radio used the hotel as its address. Besides opening the mail, the meeting room was at the disposal of sales clerks for their wares and samples. Tables and chairs were equipped for that purpose and furnished by the hotel.
Upon delivery of the mail, the employees of the advertiser, along with two employees of the radio station, opened the mail. During the meeting, the radio station and the advertisers divided payments received in the mail. The radio station's deposited its share of the money (checks) to the radio station's credit in one of two banks: in Eagle Pass or in a bank in Piedras Negras. The court noted that the place of signing a contract was not determinative in determining the source of this type of income.
The radio station at Piedras Negras was a powerful one, broadcasting on fifty kilowatts in 1936 and 1937, and the advertisers got listener responses over a wide area, from nearly all of the states in the United States. The station also received mail from Canada, Cuba, and New Zealand. The Piedras Negras station had no directional antennae; the waves radiated by the antennae went in all directions with equal force. About 95 percent of the station's income was from American advertisers, and about 90 percent of the listener responses to the advertisers came from the United States.
The entertainers and announcers who put the programs on the air went to the studio in Piedras Negras, Mexico. The radio station generally employed the entertainers or musicians and furnished the programs that were broadcast. However, sometimes the advertisers would do so. In the latter instances, radio station furnished only the time on the air.
The judge noted that the IRS considered the activities at the meeting room as to constitute doing business in Texas, and thus the source of income was within the United States. The IRS argued that radio station's income came from the division in Eagle Pass, Texas.
Although the IRS wanted the meeting room to be "an office or fixed place of business," the court held otherwise. The judge stated,
Nor should greater effect be given to the use by radio station of a room in the hotel in Eagle Pass, Texas, for the purpose of sorting the mail received by advertisers and dividing the proceeds of remittances received. No rent was paid for the room and no furniture or desk was owned or maintained therein by the radio station. It was a basement sample room donated by the hotel, obviously because of the patronage realized from those in connection with the broadcasting operations. It was not an office in any usual sense. As a place of business it was only incidental - for the sorting of mail and collection of income. Regulations 94, article 231-1(b), says in part: Whether a foreign corporation has an office or place of business within the United States depends upon the facts in a particular case. The term office or place of business, however, implies a place for the regular transaction of business and does not include a place where casual or incidental transactions might be, or are, effected.
The use of the meeting room for samples was not "casual" but daily. Yet the court ruled that it was "only incidental," allowing the radio station not to have a United States business
Many tax planners believe that "negotiating" a contract in the United States causes all future profits to be domestic source. This is not the case. The judge stated,
However, the only indication of the use of that company or name for solicitation in the United States is the fact of registration in the assumed name records of Maverick County, Texas. Internal activities of a corporation, such as holding a stockholders' meeting, do not constitute transacting business. Nor is collection of debts, nor litigation to so collect, doing business [as argued in] Equitable Credit Co. v. Rogers, 299 S.W. 747; Continental Assurance Co. v. Ihler, 26 Pac.(2d) 792.
The contract's venue of Maverick County, Texas, for litigation was immaterial to the judge. Further, the place of signing a contract was not determinative in determining the source of this type of income.
The judge was specific regarding sourcing:
Income has been defined as the gain derived from capital, from labor, or from both combined, or from the sale or conversion of capital assets [as argued in] Eisner v. Macomber, 252 U.S. 189. In Paul and Mertens' Law of Federal Income Taxation, vol. 4, p. 350, it is said, in part:
[The source] is not a place, it is an activity or property. As such, it has a situs or location; and if that situs or location is within the United States, then the resulting income is taxable to nonresident aliens and foreign corporations.... Thus, if an income be taxed, the recipient thereof must have a domicile within the jurisdiction, or the property or activities out of which the income issues or is derived must be situated within the jurisdiction so that the source of the income may be said to have
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Table of Contents
ContentsPreface: How to Use This Book....................xi
Chapter One: Foreign Trusts in America....................1
Chapter Two: Fundamentals of International Taxation for Businesses....................35
Chapter Three: Taxation of US Shareholders of Foreign Corporations....................87
Chapter Four: Foreign Tax Credit....................165
Chapter Five: Taxation of Foreign Persons Doing Business in America....................247
Chapter Six: Cross-Border Estate Planning....................275
Chapter Seven: Advanced Topics....................293