Source of Income Tx 8300

1. Source of IncomeTx 8300

2. Learning Objectives • Explain why the source of income is important to both ____ and _______ persons and • Determine the source of income for a variety of transactions You should be able to:

3. Observations about Source Rules • Appear in §§___-___, ___ • Categorize income as U.S. or foreign • Don’t ______ tax • Based on _____ of income • Treaties might ______ • Fundamental to understanding Subchapter __

4. Importance of Source Rules • U.S. taxpayers claim the ______ ___ _____ for foreign income tax paid or accrued. • However, the ___ is limited to the result of the following formula:

5. Importance: FTC Example Domco earns $____ U.S. taxable income and $____ foreign taxable income. The U.S. and foreign tax rates are 35% and ___%, respectively. What is Domco’s foreign tax credit?

6. Importance of Source Rules • The U.S. taxes _______ persons on two categories of income: • ___________ connected income • ____ source __________ income

7. United States Defined • 50 states and ____ • ___ space • ___ nautical miles from shores • Continental shelf for _______ deposits • ___________ not included • U.S. _________ not included

8. General Source Rules Depends on where ________ residence or organization Interest income Dividend income Depends on _____________ organization Personal service income Depends on where person _______ service Rental income Depends on _________ of tangible property Depends on where the licensee ____ intangible property Royalty income

9. General Source Rules Real estate gain Depends on real estate’s _________ Personalty gain Depends on type of _________ Underwriting income Depends on location of _____ Transportation income Depends on ______ and destination Communication income Depends on _________ of transmitting person

10. Interest Income Depends on ________ residence or organization General rule For ___ or ___ meeting the ___% active foreign business test, interest either pays to: Unrelated persons • Related persons Prorated based on source Interest foreign branch of ____ bank or S&L pays Interest U.S. business of ___ pays Interest ____-owned FC (with ≥ ___% U.S. CE&P) pays to ___% U.S. shareholder For FTC purposes, prorate based on source of CE&P

11. Interest Income: Example A corporation pays $1,000 interest to Robinet, a Tunisian national and resident. The corporation makes auto parts and derives ___% of its gross income from foreign business. Assuming the corporation conducts no U.S. business through branches, how much interest is foreign source income to Robinet?

12. Interest Income: Example Domco hires Ping, a Chinese national and resident, as its sales agent in China. Since Ping will be handling Domco’s finances, the agency relationship requires Ping to post security, which Domco deposits in its account with _______ Bank. Ping receives interest from the security deposit. Assuming Domco is not an _____ company, is Ping’s interest from U.S. sources?

13. Dividend Income Depends on distributor’s place of _____________ General rule Dividends FC pays when ≥ ___% of its gross income is ECI Prorate based on ____ during __-year testing period Dividends FC pays from E&P accumulated as a ___ Dividends ____-owned FC (with ≥ ___% U.S. E&P) pays to ___% U.S. shareholder For FTC purposes, trace source on _________ basis

14. Dividend Income: Example A corporation pays a $1,000 dividend to Robinet, a Tunisian national and resident. The corporation derives ___% of its gross income from foreign business. How much of the dividend is foreign source income to Robinet?

15. Dividend Income: Example Ross, an NRA, owns all shares of Forco. Forco derives ___% of its E&P from Canadian business, ___% from U.S. business, and ___% from Canadian investments. What is the source of $100 dividends Ross receives from Forco?

16. Personal Service Income Depends on where person renders services General rule Compensation ≤ $_____ to NRA present in U.S. ≤ ___ days when services rendered for: Foreign person not conducting U.S. business or Foreign office U.S. person maintains Depends on where services ______ be performed Compensation under covenants not to compete U.S. Social Security benefits

17. Personal Service Income Depends on _______ residence Alimony Depends on ________ residence Scholarships, fellowships, prizes, awards Grants to study or research abroad and achievement awards for activities occurring abroad

18. Personal Services: Example Brooke, a ____ citizen, worked in Sri Lanka for two weeks, making $1,000. She performed the services on behalf of a U.S. missionary board. How much of this income is foreign source income?

19. Personal Services: Example Halim, an ____, receives $2,000 for a drug-free root canal he performs during a one-month vacation in the United States. How much of the $2,000 is U.S. source income?

20. Rent and Royalty Income Depends on property’s ________ Rental or leasing income Depends on location where intangible can be ____ Royalty income

21. Rental Income: Example Lemon Limousines, a ____ company, leases vehicles for use in ______. What is the source of this income for U.S. tax purposes?

22. Royalty Income: Example ChemPac, a ____ partnership, licenses a secret ingredient for use in South America. What is the source of royalty income that ChemPac receives?

23. Gain from Selling Realty Depends on property’s location General rule Foreign person’s gain from selling ___ shares representing a “U.S. real property interest”

24. Gain from Selling Personalty • Gain is U.S. source income to “U.S. _________” and foreign source income to “____________.” • General rule applies only to sale of: • Intangibles where gain is ____contingent • Stockholdings (except some ___ _______) • _____ instruments • ________ investment assets • ________-use assets

25. U.S. Residents Under §865 • NRAs with ____ ___ homes • Domestic corporations, trusts, and estates • U.S. citizens and residents • Without ______ tax homes or • With ______ tax homes who pay __ ____ foreign tax on gain

26. So Many Exceptions • General rule has limited application • Exceptions for: • Inventory • __________ property • _____ of foreign affiliate • Sales via _______ business office • Sales via ____ business office

27. Personalty Gain: Inventory Purchase and resell Depends on _____ transfer Produce and resell Depends on where ________ and _____ Purchase in U.S. possession and sell in U.S. Partially _______ source income Harvest or extract in U.S. and sell abroad Depends on export ________ FMV Cut unprocessed softwood timber in U.S. and sell abroad ____ source income

28. Inventory Gain: Purchase-Resell • Involves only one ________ activity • Depends entirely on where ____ occurs • Where do ________ of ownership and _____ of loss transfer? • Title passage per ____ ________ • Otherwise, refer to ________ terms

29. Presumption Per Shipping Terms Title passes at the designated point, whether shipping or destination Title passes at shipping point Title passes at shipping point even when destination is designated point

30. Inventory Gain: Example Domco purchases merchandise from a ____ subsidiary for $100 and sells it to a ____ customer for $180. What is the source of the $80 profit?

31. Inventory Gain: Example Domco purchases merchandise from a Japanese exporter for $100 and sells it to a _______ distributor for $180. Assuming Japanese exporter passes title in _____ and Domco passes title in _______, what is the source of the $80 profit?

32. Inventory Gain: Example Forco purchases auto parts from a ____ exporter for $100 and sells them to a ____ retailer for $180. What is the source of the $80 profit if Forco passes title in _______?

33. Inventory Gain: Produce-Sell • Involves ___ economic activities • Three methods • _____ method • Independent _______ price method • Regular sales to • _________ distributors • Books and _______

34. Independent Factory Price Unrelated Distributor Retailer U.S. Manufacturer Retailer

35. Inventory Gain: Example Domco manufactures merchandise in ____ (cost $100) and sells it to a ____ customer for $180. Under the 50-50 method, how much of the $80 profit is U.S. source income?

36. Inventory Gain: Example Domco manufactures merchandise in ____ (cost $100) and sells it to a ____ customer for $180, transferring title ______. Domco regularly sells to unrelated U.K. distributors for $____. Under the IFP method, what is the source of the $80 profit?

37. Personalty Gain: Depreciable Portion of gain attributable to prior depreciation or amortization Depends on prior _____________ of deductions Excess gain for depreciable personalty Depends on _____ transfer Excess gain for amortizable personalty Depends on ________ (if non-contingent) or ___ (if contingent)

38. Depreciable Personalty: Example Five years ago, Domco purchased construction equipment for $75,000 that it used entirely within the U.S. Domco claimed $______ depreciation, reducing the equipment’s basis to $45,000. Then, Domco sold the equipment to a Canadian outfit for $______. If title passes in _______, what is the source of Domco’s $35,000 gain?

39. Gain from Selling Foreign Affiliate • If DC • Sells stock of ___%-owned ___ and • Sale occurs where ___ derived > ___% of gross income from active business in past 3 years, • Gain is ___.

40. Foreign Affiliate: Example Since its creation, Forco (Domco’s wholly-owned FC) has derived all its income from business activities in ________. If Domco sells all its Forco shares, how is the gain sourced?

41. Gain via Foreign Business Office • If U.S. resident • Sells • __________ assets (other than shares in foreign affiliate) or • Intangibles (where income is ____contingent) • Using ________ business office and • Pays ≥ ___% foreign income tax, • Gain is ___.

42. Foreign Office: Example Domco’s ________ business office sells Exxon bonds, realizing gain of $100,000. How much of the gain is foreign source income?

43. Gain via U.S. Office • Notwithstanding any other rules, • If a ___________ sells personalty through a ____ business office, • Gain is ____ unless • Personalty is _________ used or consumed abroad and • Nonresident’s _______ ______ materially participates in the sale.

44. U.S. Office: Example Forco’s U.S. branch sells sleepwear to U.S. retailers. Title transfers in ________. How is the profit sourced? Assume the same facts except that Forco’s ____ office sells directly to U.S. retailers. How is the profit sourced?

45. Underwriting Income Life and health insurance Depends on individuals’ _________ Property insurance Depends on property’s ________ Liability insurance Depends on where __________ occur

46. Transportation Income • Income from ________ transportation is USSI. • Income from transportation beginning or ending in the U.S. follows _____ rule. • Personal services • If related to transportation between U.S. and foreign country, it’s sourced as ________ services. • NRAs temporarily in U.S. as regular _____ members of foreign vessel earn ____.

47. Transportation Income: Example A vessel loads cargo in Miami and steams to Argentina where it offloads the cargo. The vessel spends ___ days in U.S. waters, ___ days in international waters, and ___ days in Argentinean waters. If the gross income attributable to this activity is $100,000, how much is from U.S. sources?

48. Int’l Communication Income U.S. persons Foreign persons: Generally Controlled foreign corporation Portion of income attributable to U.S. fixed place of business

49. Space, Ocean, and Antarctica U.S. persons But, to extent attributable to foreign functions, resources, or risks Foreign persons But, to extent attributable to U.S. functions, resources, or risks: Foreign persons engaged in U.S. business or Controlled foreign corporations