Tax Practice Corner

Taxing International Transactions: A World of Difference

Globalization has brought many new opportunities for U.S. businesses. By pursuing broader horizons, however, your clients can find themselves in unfamiliar shoals of the tax code. Here are 10 of the leading situations in which clients might need help navigating through international transactions. A “person,” in these tips, can mean a business entity, estate or trust, as well as an individual.

U.S. property is purchased from a foreign person. Withholding tax, generally 10%, can be required for purchases of U.S. real estate from a foreign person—even for a personal residence, if the amount realized exceeds $300,000, under IRC section 1445(b)(5). Even a buyer of non-publicly traded stock in a U.S. corporation may be liable for withholding if the corporation owns or owned real property.

Payments are made to a foreign person. Payees need to be aware of the types of income that are subject to withholding. They include rent, royalties, interest, dividends, license fees and U.S. source income that is not “effectively connected” with a U.S. trade or business. Persons making payments should either obtain representations from sellers that they are not subject to withholding or determine the proper withholding before any payments change hands. Payments may need to be reported on forms 1042, 1042-S or 1042-T.

A foreign person acquires stock in a U.S. corporation. U.S. corporations may be subject to reporting requirements in addition to withholding. A corporation that becomes at least 25% foreign owned may be required to file form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business.

A foreign person becomes a partner in a U.S. partnership. A U.S. partnership’s reporting requirements increase when it has foreign partners. For example, the partnership may be required to file form 8805, Foreign Partner’s Information Statement of Section 1446 Withholding Tax.

A U.S. person becomes a partner in a foreign partnership. U.S. members of foreign partnerships, including LLCs that elect to be treated as a partnership or disregarded entity, cannot assume the partnership will file U.S. taxes. Thus, they may be required to file form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships.

Transactions are denominated in a foreign currency. The number and complexity of book-to-tax adjustments increase with international transactions. A common example is when transactions are denominated in a foreign currency. Open transactions are recorded for book purposes but are not included in taxable income until the transaction closes.

A U.S. person controls or has an interest in a foreign account. U.S. persons with an interest in or control over foreign bank or other financial accounts may be required to file form TD F 90-22.1, Report of Foreign Bank and Financial Accounts, if the accounts’ aggregate value exceeds $10,000 at any time in a calendar year. The form is an informational return only and does not generate a tax liability. But failing to file it can result in monetary and criminal penalties, says CPA Linda C. Maxwell-Fisher. “The Treasury Department, together with Homeland Security, is attempting to trace large sums of money of U.S. citizens and residents,” she said.

Property or currency is transferred into or out of the United States. Aggregate transfers of more than $10,000 may need to be reported on FinCEN form 105, Report of International Transportation of Currency or Monetary Instruments. Monetary instrument is defined broadly and includes signed checks where the payee’s name has been omitted. Property transfers may need to be reported on IRS form 8865, schedule O, Transfer of Property to a Foreign Partnership; form 926, Return by a U.S. Transferor of Property to a Foreign Corporation; or form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts.

Operations are conducted in a foreign country. Businesses need to be aware of what types of activities subject them to another country’s filing and tax requirements. Even a small adjustment may avoid a tax liability.

International transactions are conducted with a related person (transfer pricing). The definition of related party is broad, and IRC section 482 is not limited to situations where one entity owns more than half of another. Any type of transfer, including a transfer of intangibles, can be subject to transfer-pricing rules.

By Susan M. Sorensen, CPA, Ph.D., assistant professor of accounting at the University of Houston, Clear Lake, Texas. Her e-mail address is Sorensen@uhcl.edu.