Outbound International Tax Considerations for U.S. Government Contractors

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1 Outbound International Tax Considerations for U.S. Government Contractors Alison N. Dougherty Aronson LLC Tel. (301) All Rights Reserved 805 King Farm Boulevard Suite 300 Rockville, Maryland P F

2 Structuring Outbound Business Activity Foreign Branch U.S. company operates directly in the foreign country U.S. company forms or acquires a foreign subsidiary company Check foreign country local law requirements 1

3 Foreign Subsidiary Company U.S. Federal Entity Classification Per se foreign corporation Foreign eligible entity Form 8832 check-the-box entity classification election Foreign disregarded entity Foreign partnership Timely election filed within 75 days of effective date Form 8832 late election relief 2

4 Foreign Corporations General Rule of Deferral Deferral = U.S. shareholder s U.S. Federal tax on income from foreign corporation is deferred until dividend is received 3

5 Exceptions to Deferral Controlled foreign corporation (CFC) with Subpart F income or earnings invested in U.S. property CFC = foreign corporation of which more than 50% of the vote or value is owned by U.S. shareholders who each own at least 10% of the voting stock. U.S. Federal taxation on undistributed earnings of CFC before actual dividend distribution is received 4

6 Exceptions to Deferral CFC s Subpart F Income Different types of Subpart F income 1. Passive income and income from certain personal service contracts performed by CFC s 25% shareholder 2. CFC s purchase from or sale to a related party of property manufactured, produced, etc. outside the CFC s country of incorporation for sale, use, consumption or disposition outside the country of incorporation 3. CFC performs services outside the CFC s country of incorporation for or on behalf of a related person 4. CFC insurance company insures risks on person or property outside the CFC s country of incorporation 5

7 Exceptions to Deferral CFC s Earnings Invested in U.S. Property U.S. Federal taxation on U.S. shareholder s pro rata share of CFC s earnings invested in U.S. property. Definition of earnings invested in U.S. property E&P limit on U.S. shareholder s inclusion 6

8 U.S. Federal Taxation Foreign Subsidiary Corporation Subcontractors Foreign subsidiary corporation is a separate distinct entity for U.S. Federal tax purposes. U.S. parent paying or funding operating expenses of the foreign subsidiary corporation should be reflected as: 1. Capital contribution U.S. parent s asset and foreign subsidiary corporation s equity 2. Intercompany loan receivable/payable with adequate documentation in the form of a promissory note with interest 3. U.S. parent s subcontractor expense and foreign subsidiary s subcontractor fee booked as revenue U.S. parent should not deduct operating expenses of a foreign subsidiary corporation on the U.S. Federal tax return 7

9 U.S. Federal Taxation of U.S. Person s Foreign Branch, Foreign Disregarded Entity or Foreign Partnership Foreign branch activity reported on the U.S. owner s U.S. Federal tax return Foreign disregarded entity same as branch Foreign partnership U.S. partner reports a distributive share of income and expense from the foreign partnership on U.S. Federal tax return. 8

10 Claiming Losses of Foreign Branch, Foreign DRE and Foreign Partnership Foreign branch and foreign DRE losses claimed Foreign branch loss recapture if foreign branch is ever incorporated Foreign partnership losses to the extent of basis in partnership interest and at-risk rules, PAL rules same as losses from a U.S. partnership 9

11 Foreign Tax Credits Foreign Corporation Foreign corporation Only U.S. C corporation 10% or greater shareholder of foreign corporation may claim indirect foreign tax credit for foreign taxes paid by foreign corporation when dividend received 10

12 Foreign Tax Credits Foreign Branch, Foreign DRE and Foreign Partnership Foreign branch U.S. corporation claims FTC on U.S. Federal Form 1120 Foreign branch U.S. partnership or S corporation passes through foreign taxes paid to partners and shareholders Foreign disregarded entity same as foreign branch Foreign partnership U.S. partner reports share of foreign taxes paid by foreign partnership on U.S. Federal tax return 11

13 U.S. Federal Reporting and Tax Compliance for U.S. Ownership of a Foreign Corporation - Form 5471 Form 5471 U.S. shareholder of foreign corporation files Form 5471 to report: 1. 10% acquisition or a disposition 2. 10% ownership interest in a CFC on last day of tax year 3. Control (ownership of more than 50%) at any time during tax year 4. U.S. person who is an officer or director in a year when a U.S. person acquires 10% 17

14 U.S. Federal Reporting and Tax Compliance for U.S. Ownership of a Foreign Partnership - Form 8865 Form 8865 U.S. partner of a foreign partnership files Form 8865 to report: 1. 10% acquisition or a disposition 2. 10% ownership interest 3. Control (ownership of more than 50%) of a foreign partnership at any time during the year 4. Transfer of cash or property to a foreign partnership if value is greater than $100,000 during 12-month period ending on date of transfer or transferor owns 10% of the foreign partnership after the transfer 18

15 U.S. Federal Reporting and Tax Compliance for U.S. Ownership of a Foreign Disregarded Entity Form 8858 Form 8858 U.S. owner of foreign disregarded entity files Form % ownership of foreign disregarded entity 2. 10% U.S. owner of CFC that owns a DRE 3. U.S. person who controls CFC that owns DRE 4. 10% U.S. owner of foreign partnership that owns DRE 5. U.S. person who controls foreign partnership that owns DRE 19

16 FinCEN Form 114 Foreign Bank Account Report Filing Requirement File FBAR if the U.S. person has a financial interest in or signature authority over a foreign account and the aggregate highest value or balance of all foreign accounts exceeds $10,000 during the calendar year. Due on June 30 th following the calendar year end Must be filed electronically 20

17 FinCEN Form 114 Foreign Bank Account Report Reportable Accounts Reportable accounts: 1. Bank deposit or custodial accounts maintained with a foreign bank or foreign branch of U.S. bank 2. Foreign investment, brokerage, securities, options, mutual fund, commodities or currency accounts 3. Foreign pension or retirement plan accounts 4. Foreign insurance policies with a cash value 21

18 FinCEN Form 114 Financial Interest and Signature Authority Financial Interest 1. Owner of record or holder of legal title 2. Owner of more than 50% in U.S. or foreign company which owns account Signature Authority right to control disposition of funds in account with written or verbal communication to bank 22

19 U.S. Foreign Reporting & Compliance for Prior Years IRS Offshore Voluntary Disclosure Program Amnesty 1. Pre-clearance and acceptance % penalty 3. File delinquent prior year foreign reporting forms 4. Amend prior year tax returns and pay penalties on underpaid taxes 5. Disclosure period 8 preceding years 6. Protection from criminal prosecution File outside program if zero unreported taxable income and zero unpaid taxes 23

20 U.S. Expatriate Employees Working Overseas Cross-Border Employment Tax and Payroll Reporting FITW exemption U.S. employee will qualify for foreign earned income exclusion and provides Form 673 U.S. employees working for foreign employer - secondment agreement. Election for U.S. employer to make FICA contributions for U.S. employees working for foreign employer if sufficient affiliation May lose FITW, FICA contributions and 401(k) eligibility if on the payroll of the foreign company without election or agreement 24

21 Foreign Income Taxation Permanent Establishment Foreign country may impose foreign taxation on income attributable to a Permanent Establishment Permanent establishment = office, fixed place of business or employees working there for a specific duration of time Status of Forces Agreements may provide an exemption from foreign income taxation for U.S. government contractors and U.S. employees of such contractors. 25

22 Foreign Taxation Types of Foreign Taxes Foreign income taxation if PE Foreign income taxation if foreign subsidiary company Foreign employment tax and payroll reporting if U.S. or foreign employees working in the foreign country Foreign value added tax (VAT) may apply to income from services, e.g., Canada HST/GST Foreign branch profits tax on repatriation of earnings from a foreign branch Foreign nonresident withholding tax on repatriation of earnings to U.S. from a foreign company 26

23 Alison N. Dougherty Tax Manager Alison N. Dougherty is a Tax Manager with Aronson LLC. Her responsibilities include Federal and multi-state tax compliance for C corporations, S corporations, partnerships and individuals. She specializes in international tax compliance and planning as part of the international tax practice. She also provides transactional tax planning and structuring services. Direct (301) Main (301) Aronson LLC 805 King Farm Blvd, Third Floor Rockville, MD Washington, DC Metro Area Alison completed the LL.M. in Securities and Financial Regulation in 2004 with academic distinction at Georgetown University Law Center. She completed the LL.M. in Taxation in 2000 and the Juris Doctor in 1999 at the University of Denver College of Law. She completed the Bachelor of Arts in Foreign Language in 1995 at Virginia Commonwealth University. 27

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