Taxation of Foreign Corporations
Foreign corporations are taxed in the United States on two categories of income:
1. U.S. source investment income, and
2. Business income earned in the United States.
Investment income is generally subject to a withholding tax in the amount of 30 percent of the gross income earned. This rate is often reduced if the recipient is a resident of a country with which the United States has an income tax treaty in force. The company or person that makes payment is required to withhold the tax and remit it to U.S. taxing authorities. If the withholding is properly remitted, the foreign corporation’s tax liability is satisfied and it will generally not be required to file an income tax return in the United States.
U.S. investment income consists primarily of dividends paid by domestic corporations, interest paid by U.S. persons, royalties earned for the use of intangible property in the United States, and gains from the sale of real property that is held for investment and located in the United States.
There are two important statutory exceptions to the taxation of a foreign corporation’s U.S. interest income. These provisions are designed to promote foreign investment in the United States. The first, known as the “bank interest exception,” provides that interest income earned by a foreign corporation on bank deposits in the United States is excluded from U.S. taxation. The second, known as the “portfolio interest exception,” provides that interest income earned by a foreign corporation on most loans made to or debt obligations issued by a U.S. person is excluded from U.S. taxation.
Foreign corporations are taxed on their net U.S. business income at graduated corporate tax rates that range from 15 percent to 35 percent. Net U.S. business income consists of gross U.S. business income less allowable business deductions. Common types of U.S. business income include:
1. Income from the sale of goods if title and risk of loss pass to the buyer in the United States.
2. Income from the sale of goods outside the United States if a U.S. office materially participates in the sale.
3. Income from the sale of goods (either inside or outside the United States) that were manufactured or produced in the United States.
4. Income from the provision of services if the person providing the services is physically located in the United States when the services are performed.
5. Rental income from the use of tangible or real property that is physically located in the United States.
6. Income from the use of intangible property in the United States.
If a foreign corporation receives taxable U.S. business income, it is required to file a corporate tax return. This income tax return is used to report the gross U.S. business income received, the related deductions, and to calculate the net tax due. Business income is generally not subject to withholding if proper exemption procedures are followed.
In addition to corporate income tax, a foreign corporation will also be subject to branch tax in the amount of 30 percent of any remittances of U.S. business profits to the foreign home office. Branch tax is similar to the tax on dividends paid from a domestic corporation to foreign shareholders in that it represents a tax on profits earned in the United States and repatriated for use outside the United States. The branch tax and dividend withholding tax rates are both 30 percent. This rate is also commonly reduced to lower levels if the foreign corporation is a resident of a country with which the United States has an income tax treaty.
Income tax treaties make significant modifications to the U.S. tax treatment of business profits earned by foreign corporations. U.S. income tax treaties generally provide that foreign corporations that qualify for benefits under an income tax treaty will not be subject to U.S. income tax or branch tax on profits from U.S. business activities unless the foreign corporation has a permanent establishment in the United States. A foreign corporation will have a permanent establishment in the United States if it maintains an office or fixed place of business in the United States or if it has employees or dependent agents that habitually enter into contracts on behalf of the foreign corporation in the United States.
The permanent establishment provisions allow foreign corporations that qualify for treaty benefits to earn all types of business income in the United States without incurring a U.S. tax liability, as long as they do not maintain a permanent establishment in the United States. This means that foreign corporations can sell goods to U.S. customers, provide services in the United States, or license intangible assets for use in the United States without incurring U.S. taxation as long as these activities do not rise to the level of a permanent establishment. This is a significant advantage over foreign corporations that are incorporated in a country without an income tax treaty with the United States.
1. U.S. source investment income, and
2. Business income earned in the United States.
Investment income is generally subject to a withholding tax in the amount of 30 percent of the gross income earned. This rate is often reduced if the recipient is a resident of a country with which the United States has an income tax treaty in force. The company or person that makes payment is required to withhold the tax and remit it to U.S. taxing authorities. If the withholding is properly remitted, the foreign corporation’s tax liability is satisfied and it will generally not be required to file an income tax return in the United States.
U.S. investment income consists primarily of dividends paid by domestic corporations, interest paid by U.S. persons, royalties earned for the use of intangible property in the United States, and gains from the sale of real property that is held for investment and located in the United States.
There are two important statutory exceptions to the taxation of a foreign corporation’s U.S. interest income. These provisions are designed to promote foreign investment in the United States. The first, known as the “bank interest exception,” provides that interest income earned by a foreign corporation on bank deposits in the United States is excluded from U.S. taxation. The second, known as the “portfolio interest exception,” provides that interest income earned by a foreign corporation on most loans made to or debt obligations issued by a U.S. person is excluded from U.S. taxation.
Foreign corporations are taxed on their net U.S. business income at graduated corporate tax rates that range from 15 percent to 35 percent. Net U.S. business income consists of gross U.S. business income less allowable business deductions. Common types of U.S. business income include:
1. Income from the sale of goods if title and risk of loss pass to the buyer in the United States.
2. Income from the sale of goods outside the United States if a U.S. office materially participates in the sale.
3. Income from the sale of goods (either inside or outside the United States) that were manufactured or produced in the United States.
4. Income from the provision of services if the person providing the services is physically located in the United States when the services are performed.
5. Rental income from the use of tangible or real property that is physically located in the United States.
6. Income from the use of intangible property in the United States.
If a foreign corporation receives taxable U.S. business income, it is required to file a corporate tax return. This income tax return is used to report the gross U.S. business income received, the related deductions, and to calculate the net tax due. Business income is generally not subject to withholding if proper exemption procedures are followed.
In addition to corporate income tax, a foreign corporation will also be subject to branch tax in the amount of 30 percent of any remittances of U.S. business profits to the foreign home office. Branch tax is similar to the tax on dividends paid from a domestic corporation to foreign shareholders in that it represents a tax on profits earned in the United States and repatriated for use outside the United States. The branch tax and dividend withholding tax rates are both 30 percent. This rate is also commonly reduced to lower levels if the foreign corporation is a resident of a country with which the United States has an income tax treaty.
Income tax treaties make significant modifications to the U.S. tax treatment of business profits earned by foreign corporations. U.S. income tax treaties generally provide that foreign corporations that qualify for benefits under an income tax treaty will not be subject to U.S. income tax or branch tax on profits from U.S. business activities unless the foreign corporation has a permanent establishment in the United States. A foreign corporation will have a permanent establishment in the United States if it maintains an office or fixed place of business in the United States or if it has employees or dependent agents that habitually enter into contracts on behalf of the foreign corporation in the United States.
The permanent establishment provisions allow foreign corporations that qualify for treaty benefits to earn all types of business income in the United States without incurring a U.S. tax liability, as long as they do not maintain a permanent establishment in the United States. This means that foreign corporations can sell goods to U.S. customers, provide services in the United States, or license intangible assets for use in the United States without incurring U.S. taxation as long as these activities do not rise to the level of a permanent establishment. This is a significant advantage over foreign corporations that are incorporated in a country without an income tax treaty with the United States.