Q4：Precision S.A., an Islandian corporation, is engaged in a golf club business in Islandia and the United States. The United States business is conducted through a branch. During each of the preceding five years, 35% of Precision’s gross income was effectively connected with the United States business.
If Precision pays a dividend of $1000 to its sole shareholder, an Islandian holding company, what is the source of the dividend income?
Question 1 Assume that your client, Reynolds, a citizen of Islandia, is present in the United States in connection with his work as an export sales employee of a Islandian corporation for the following days during the calendar years at issue: 2014 (138 days), 2015 (150 days) and 2016 (120 days). When in the United States, Reynolds operates out of a small office in Los Angeles leased by his employer. He owns a condominium in Pasadena, where he keeps a car registered in California and personal belongings such as furniture and clothes. He is a member of a country club in Century City. He was born and raised in Islandia, owns an apartment there, keeps a car there (registered in Islandia), and has personal belongings there (such as furniture, an art collection and clothing). He is a member of a golf club in Islandia. All his family members live in Islandia. The principal office of his employer, where he is headquartered, is located in Islandia. He has an international driver’s license. He is a citizen of Islandia and all official documents identify him as an Islandian resident. He votes in Islandian elections. Reynolds does not hold a U.S. green card and he has not elected to be treated as a U.S. resident. Will Reynolds be treated as a United States resident for 2016? An individual taxpayer will be characterized as a US person if he/she is a US citizen, or holds a US green card, or passes one of the Substantial Presence Tests. In order to pass SPT1 an individual must be present in the US for 183 days or more. In order to pass SPT2, an individual must meet the following elements: 1) in the US for 31 days or more in the current year, AND 2) in the US for 183 days or more over the last 3 years using the weighed calculation, AND 3) not have a closer connection to a foreign tax home (this last requirement is a subjective test). Since Reynolds is not a US citizen and does not have a US green card the only way he could be a US person is if he passes one of the Substantial Presence Tests. He does not pass SPT1 because in 2016 he was in the US for less than 183 days. He meets element 1 of SPT2 (in the US for more than 31 days in 2016) He meets element 2 of SPT2 (in the US for more than 183 days over the last three years using the weighed calculation: 2014: 138 days / 6 = 23 days 2015: 150 days / 3 = 50 days 2016: 120 days = 120 days Total days = 193 days Reynolds would therefore be a US person if he meets element 3 of SPT2 (closer connection to a foreign tax home). This is a subjective element and you must weigh the available facts to reach a conclusion. Since this is a subjective test there is not necessarily a right answer (you will receive credit if you addressed it and conducted an analysis). However, the facts appear to indicate that he has more important connections with Islandia. What advice would you give him to reduce his chances of being treated as a United States resident in 2017? To avoid the subjective test altogether, Reynolds should spend less than 117 days in the US in 2017. This would cause him to fail element 2 of SPT2 and it would not be necessary to perform the analysis for element 3. Also, Reynolds should rent the apartment and lease the car in the US to further bolster his argument that he has a closer connection to Islandia. Question 2 Under what circumstances would an alien individual want to make the first-year election to be treated as a United States resident for U.S. tax purposes? A non-US person is subject to a gross tax of 30% on FDAP income. Under this regime no deductions is permitted. Hence, if a non-US person had expenses in the US or could fall into a marginal tax rate below 30% it would be in their interest to be taxed as a US person since US persons are subject to a net tax (gross income less deductions) at marginal tax rates. Question 3 Sammy is a Canadian citizen who lives and works primarily in Canada (you can assume he is a Foreign Person with a “tax home” in Canada). Sammy purchases trucks in the U.S. for $400,000 which are used solely in the transportation of inventory purchased in different parts of the United States to U.S. customers. The trucks are deemed to be assets that generate U.S. trade/business income. Sammy took depreciation deductions on the trucks of $200,000 which were applied to reduce U.S. source income. Suppose that Sammy resells the used trucks for $410,00 (thereby realizing gain of $210,000) to a foreign purchaser that took title to the trucks in Islandia. What is the source of the income realized on the sale of the trucks? To the extent that gain is depreciation recapture of depreciation deductions taken against US source income, that income is US source income. In this case, $200,000 of the gain is depreciation recapture of depreciation deductions taken against US source income so $200,000 is US source income. The remaining $10,000 is sourced according to where title passes. Since title passes in Islandia, the remaining $10,000 of gain is foreign source income. Question 4 Precision S.A., an Islandian corporation, is engaged in a golf club business in Islandia and the United States. The United States business is conducted through a branch. During each of the preceding five years, 35% of Precision’s gross income was effectively connected with the United States business. If Precision pays a dividend of $1000 to its sole shareholder, an Islandian holding company, what is the source of the dividend income? The General Rule for sourcing dividends is to look at the Residence of the corporation issuing the dividend. There is an exception if a foreign corporation is paying a dividend and 25% or more of foreign corporation's income is from a U.S. trade/business (over the last three years). Under the exception, the U.S. source portion of the dividend equals the portion of U.S. TB income. In this case the Precision, corporation paying the dividend, is a non-US person since it was incorporated in Islandia. However, 35% of its gross income was from a United States trade/business. As a result, $350 (35% of the dividend) will be US source income and the remaining $650 (65% of the dividend) will be foreign source income. Question 5 Sunquest Inc., a U.S. corporation, purchases a variety of skin care products from unrelated U.S. suppliers and sells them at a profit to unrelated retailers in Islandia. Sunquest also manufactures cosmetics in the United States and sells them to unrelated retailers in Islandia. Title on all of the sales passes from Sunquest to the purchaser at the international airport in Islandia when the goods arrive. What is the source of the income realized by Sunquest from these transactions? The general sourcing rule for inventory is to base it on where title is transferred. However, if the inventory is manufactured in the US the income must be sourced in the US. Skin Care Products: Since Sunquest regularly sells skin care products we can categorize the income as gain from the sale of inventory. In this case title transfers at the airport in Islandia so the gain from the sale of the skin care products would be Foreign Source income. Cosmetics: Since Sunquest manufactures the cosmetics in the US the income must be sourced in the US. Question 6 Worldnet, Inc., a U.S. corporation, has interest expenses for the tax year of $200,000, no portion of which is directly allocable to identified property under the regulations. Worldnet’s total assets have an adjusted basis/book value of $5,000,000 and a fair market value of $10,000,000. The assets generating U.S. source income have an adjusted basis/book value of $4,000,000 and a fair market value of $6,000,000. How much of the interest is apportioned to U.S. source income? Interest expense is allocated as US source in proportion to the basis of its assets that produce US source income. Worldnet’s assets have the following basis and FMV: US For Total Book Value: $4M (80% of total) $1M $5M FMV: $6M (60% of total) $4M $10M Using the basis, Worldnet can allocate 80% ($4M/$5M) of its interest expense as US source. Of the $200,000 of interest expense, $160,000 would offset US source income.