Jurisdiction

1) Residence jurisdiction (personal)

- Jurisdiction to tax worldwide income of residents regardless of where it is earned
- Historically a lot of countries did not tax foreign source income of their residents
2) Source jurisdiction
- Non-residents only taxed on domestic source income
Issue: what to do about residents that become non-residents?
- Much easier to become a resident for the purposes of worldwide tax than it is to
become a national
Subdivisions within residence and source jurisdiction
1) Active income
a. Low for residents
b. High for non-residents
2) Passive income
a. Low for non-residents
b. High for residents
-

Double taxation issue

Next week: defining residency

Defining residency
1) Individuals (natural persons)
- Physical presence test: used by most countries in the world
o If more than 183 days, then you are a tax resident
High bar because you are in that country more than any other for
that tax year
Low bar because its also relatively easy not to be a resident of any
country
o US Rule: days in current year + 1/3 of preceding year + 1/6 of second
preceding year
o Exceptions
Students
Medical tourists
- Citizenship + green card
o Automatically considered a resident alien for tax purposes
o Taxpayers burden to live overseas for business or personal reasons not
tax reasons
o Exit taxes: expatriation tax for renouncing citizenship or ending residency
for tax purposes

2) Corporations
- US Rule: place of incorporation (301.7701) Followed by some countries but not
the majority
- US shareholders own 100% of a foreign corporation not a taxable corporation
o Even if the corporation is clearly a shell
o Easy to rely on this rule to avoid corporate taxation
o Until recently you could give up citizenship and collect all the money
(after 2008, there is now the exit tax)
- Issue:
- 4 factors for corporation vs. partnership if incorporated overseas
o Unlimited life
o Limited liability
o Future transferability of shares
o
- Check the box rule: arrival of LLCs
o Per se corporations
C corpt
S corp
o Other eligible entities
Partnerships
Disregarded entities sole proprietorships
- Fundamental tax planning device is to derive foreign source income as a foreign
corporation
SOURCE RULES
Foreign tax credit
- Foreign source income: 100
- Foreign tax: 30
- US income: 100
- US tax: 35
- FTC: (30)
But if foreign tax is 50 (higher than US tax, then the treasury will have to issue a check
for 15) then its just a transfer of funds from US treasyry to foreign treasury
Foreign tax credit limitation
- US tax rate x foreign source income
- So even if your foreign tax is higher, you dont get more than the US rate for the
FTC
Formal
- 1) Dividends: residence of the payor
- 2) Interest: residence of the payor
- 3) Capital gains: residents of the seller

4) Sales of purchased goods: passage of title

Substantive
- 1) Royalties: place of use
- 2) Rents: place of use
- 3) Services: place of delivery
- 4) Sales:
- Derivatives: 1.863-7
DEDUCTIONS
General rule
- 1) Allocate deduction to income
- 2) Apportion deduction between US and foreign source income
B&D US 100% subsidiary B&D Japan
- Write off bad investment
- Suppose you had a successful investment in Japan, dividends paid out of foreign
source income, deductions is also foreign source
- Deduction didnt generate any income here (because you have a loss)
- But had they made income, what kind of income would they have made?
Dividend income
- If they had sold it, it would have been capital gain
ROYALTIES
R&D deduction
- 50% source based on location
- 50% apportioned based on either
o Gross income overall, OR
o Gross sales
- Rule change in 1986:
o Playing games
o Why does the new rule produce better results
INTEREST
Domestic parent company controls foreign company
- D has 1000 in US assets
- F has 1000 in foreign assets
- IRS passed rule: if you deconsolidate for this purpose, it counts as if you didnt
deconsolidate
F
Gross income of 100

Income expense of 50
Net income of 50
D
Gross US income 100
US income expense 33
Net income 67
Foreign income 50
Foreign income expense 17
Net income 33
If foreign tax rate is the same as US tax rate, the foreign tax credit will wipe out potential
taxation of the foreign income
Exceptions to witholding
1) capital gains
2) interest (portfolio interest exception)
3) royalties (mostly treaties)
4) dividends
END OF CHAPTER 4
Net tax on income that is effectively connected with a US trade or business (permanent
establishment)
US trade or business
- (1) physical presence in US
o directly
o through a dependent agent
- (2) trading in securities and commodities not in US trade or business
o safe harbor
Effectively connected income (ECI)
- residual force of attraction rule: if something is not FDAP and not CG (inventory
sales)
Transfer pricing method
- comparable uncontrolled price: traditional gold standard of transfer pricing
- cost plus
- resale price
- CPM
- profit split
APAs are controversial (agreement with IRS about how much tax you are going to pay)

R&D