Bus 225D – International Tax Individuals and Foreign Corps Instructor: Carol Rutlen, CPA

2 Overview of webinar series Syllabus Need access to Code and Regs in class Ask questions Need feedback on format Agenda for Class - Introduction

3 Goals of the Webinar Series Understand the special rules and concepts associated with mobile employees Taxation of foreign corporations doing business in the US Issue recognition Multi-jurisdictional Real world environment

4 Introductions Tax experience Experience with expats, aliens, and international issues What you want out of the class

5 International tax concepts US: Who gets taxed and how they are taxed What’s included in international compensation package and how is it taxed Tax equalization concepts Corporate tax and legal issues Agenda for Today - Overview

6 International Tax Concepts Taxed on personal relationship between taxpayer and country –US citizens –Resident aliens –Domestic corporations Taxed on economic relationship between taxpayer and country –Nonresident aliens –Foreign corporations Double taxation when taxpayer has personal relationship with one country and economic relationship with another country

7 Territorial vs. Credit Systems Traditionally home country solves double taxation problem of citizens and residents Territorial system –Taxed on income derived from sources within home country –Not taxed on income from foreign sources Credit system –Taxes foreign income –Allows a credit for foreign taxes paid

8 Foreign Tax Credit Home Country Host Country Total Earned$100 Taxed$100 Tax Rate30%20%50% Territorial System $20 Credit System $30$20$50 FTC-20 Net Tax$10$20$30

9 Tax Treaties Unilateral solution – territorial and credit systems Bilateral solution – tax treaties –Reciprocal tax exemptions –Lower tax rates Shift primary tax jurisdiction from host country to home country Increase in home country’s revenue at host country’s expense

10 Overview of US System US uses credit system Claim FTC on foreign-source income Deferral provisions –Foreign-source income earned by US person through foreign corporation not taxed until repatriated through dividend distribution –Foreign earned income exclusion

11 US Taxation of International Transactions US person –Foreign source income: US collects the excess of the pre-credit US tax over the related foreign tax credit Foreign person –Income effectively connected with a US trade or business: US taxes the net amount of income at graduated rates –US source nonbusiness income: US taxes the gross amount of income at 30%

12 Terminology – Tax vs. Company Definitions Expatriate –IRC Sec. 911 provides for citizens or residents of the US living abroad Inpatriate/Alien/Foreign national –IRC Sec. 7701(b) defines resident and nonresident aliens Third Country National (TCN)

13 US Tax Status Citizen –Taxed on worldwide income –Regardless of where it is earned and where it is paid Resident –Defined in IRC Sec 7701(b) –Taxed like citizen Non-resident –Defined in IRC Sec 7701(b) –Taxed on US source income

14 Length of Assignment Company definition vs. tax definition Common categories –Business trip –Extended business trip –> 1 year –> 3-5 years Potential double taxation for –Income tax –Social tax –Estate tax

15 Reasons for International Assignments Technical needs –Company pays extra costs Developmental needs –Company may pay extra costs Employee requests –Company may treat as local hire

16 Components of Compensation Balance Sheet –Provide employee with similar purchasing power in home and host locations –Common in US-headquartered MNCs (multi- national company) –Review Annual Compensation Summary –Incorporates tax equalization –Updated frequently Net Pay –Employee has same after tax pay in home and host location –Common in European-headquartered MNCs –Usually won’t change during an assignment

17 Net Pay Example HomeHost Salary$100$140 Tax rate30%50% Tax$30$70 Net after tax income $70

18 Principles of Taxing Compensation Definition of wages –What is taxable? Withholding federal income tax –When do you withhold? Sourcing within or without US –How do you avoid double taxation?

19 Taxability of Compensation Tax definition of wages: IRC Sec. 61 Gross Income Defined. (a)General Definition – Except as otherwise provided in this subtitle, gross income means all income from whatever source derived, including (but not limited to) the following items: (1) Compensation for services, including fees, commissions, fringe benefits, and similar items.

20 Taxability of Compensation Qualified plans –IRC Sec 401. Qualified pension, profit-sharing, and stock bonus plans. –IRC Sec 402. Taxability of beneficiary of employee’s trust. (a) Taxability of beneficiary of exempt trust. – Except as otherwise provided in this section, any amount actually distributed to any distributee by any employees’ trust described in section 401(a) which is exempt from tax under section 501(a) shall be taxable to the distributee, in the taxable year of the distributee in which distributed. Do all plans qualify under Sec 401?

21 Impact of §409A New regulations issued 4/10/07 Unless certain requirements are met, amounts deferred under nonqualified deferred compensation plan are included in gross income and subject to 20% penalty tax Exception –Foreign nationals (not permanent residents) Broad-based foreign retirement plans –Permanent residents and US citizens Broad-based foreign retirement plan related to non-US services

22 Compensation Definition of wages –Taxable regardless of where paid or where earned Withholding federal income tax –When do you withhold? Sourcing within or without US –How do you avoid double taxation?

23 Taxability of Compensation Withholding required on wages Subchapter A – Withholding from Wages IRC Sec Definitions. (a) Wages. – For purposes of this chapter, the term “wages” means all remuneration (other than fees paid to a public official) for services performed by an employee for his employer, including the cash value of all remuneration (including benefits) paid in any medium other than cash; except

24 Taxability of Compensation Wages for withholding except –3401(a)(5) services for a foreign government or international organization –3401(a)(6) services performed by a nonresident alien individual –3401(a)(8)(A) for services for an employer (other than the US…) – (i)Performed by a citizen of the US if … that remuneration will be excluded from gross income under Sec 911; or (ii)Performed in a foreign country by such a citizen if …the employer is required by law in the foreign country … to withhold income tax upon such remuneration

25 Compensation Definition of wages –What is taxable? Withholding federal income tax –Withholding required unless Nonresident alien Qualify for Sec 911 exclusion Subject to non-US withholding –Irrelevant whether paid out of US or no US paymaster Sourcing within or without US –How do you avoid double taxation?

26 What is included on Form W-2? US expats –Paid in the US –Paid out of the US What if not hired by US company? Resident/nonresident aliens –Paid in US –Paid out of the US –What if no US paymaster?

27 Taxation in Home/Host Country Usually taxable in host country if present more than 6 months Tax in home country ceases if absent more than 1 year Except US citizens Offsets available in the US against non-US source income –Section 911 exclusion ($91,500 in 2010) –Foreign tax credits

28 IRC Sec 861. Income from Sources within US (a)Gross income from sources with US. – The following items of gross income shall be treated as income from sources within the US (3) Personal services. – Compensation for personal services performed in US; except … shall not be deemed to be income from sources within US if- (A) the services are performed by NRA temporarily present in US < 90 days during year, (B) compensation does not exceed $3,000 in aggregate, and (C) employer not engaged in trade or business in the US

29 IRC Sec 862. Income from Sources without US (a)Gross income from sources without US. – The following items of gross income shall be treated as income from sources without the US (3) compensation for labor or personal service performed without the US

30 Sourcing Compensation Sourced on workdays § (b)(2) –Salary –401(k) –Goods and services differential

31 Sourcing Compensation Attributed to specific location § (b)(2)(ii)(D) –Housing- Foreign taxes –Education allowances- Hazard duty or hardship –Transportation- Reimbursed moving exp Multi-year compensation § (b)(2)(ii)(F) –Bonus –Stock awards

32 Other Compensation Issues Local law vs. tax treaties –General rule – treaties override local statute –Covered in future class Exchange rates –Paid in currency other than US $ –Covered in various classes

33 Tax Equalization Basics Common business practice Allocate tax cost under balance sheet method Mechanics Taxability of hypothetical tax and tax equalization

34 Allocating Tax Cost 100,000Salary 30,000 Tax if home (Represents hypothetical) host 10,000Excess tax cost (40,000 – 30,000)

35 Mechanics of Tax Equalization W/O AssignmentWith Assignment W-4 = withholdingEstimate stay-at- home hypothetical tax Withhold tax each pay period Withhold hypothetical each pay period Host country tax YE tax return compare actual to withholding YE tax equalization compare actual to hypo withholding

36 Taxability of “Tax Components” Is there “constructive receipt” of hypothetical tax? Are tax payments considered an advance or wages? –Similarity to employee advances –Documentation important –Consistency required between employer and employee

37 Impact of §409A Tax equalization exempted Payment must be made within two tax years that begin after the later of: –The deadline for filing a US return (including extensions) –The deadline for filing a foreign return (or the due date of the foreign tax payments)

38 Impact of §409A – Example John on assignment in return extended to 10/15/ foreign tax paid January 2008 When does tax equalization have to be paid to fall under §409A exemption?

39 Taxability of “Tax Components” How is the tax equalization sourced? –US payments –Non-US payments § (b)(2)(ii)(D)

40 Corporate Issues for Intl Assignments Who gets the deduction? Secondment of employee –Who is the employer? –Who has the right to hire and fire? –Which companies benefits programs apply? –Permanent Establishment of employer in host location Legal issues –Access to US court system

41 Who gets taxed and how they are taxed –Definition of wages –What is subject to withholding –US citizen vs. resident vs. nonresident –Sourced within and without US What’s included in international compensation package and how is it taxed/sourced Key Points

42 Tax equalization concepts –Hypothetical tax vs. tax equalization –Constructive receipt –Tax advances –409A Corporate tax and legal issues –Who is the employer –Secondment –Permanent establishment Key Points

43 Contact Information Carol Rutlen