Identifying and reporting the proper taxpayer in international structures.

• Author: Share, Leslie A.

One of the most basic issues in U.S. tax law is the determination of the appropriate person or entity subject to tax and the accompanying compliance obligations with regard to a particular payment or other income item. When a non-U.S. entity appears to be the taxpayer in question, its classification for U.S. tax purposes is often crucial, especially when its status may not be obvious from its name or governing documents. In addition, especially in the international context, the actual recipient, titleholder, or beneficiary of the item in question is not always necessarily the "real" taxpayer in question. The IRS and U.S. courts on many occasions have dissected complex income streams and planning structures in the attempt to identify the actual responsible reporting party. Because offshore transactions and inbound and outbound tax planning activities are often highly scrutinized by the IRS, international tax practitioners will need to be extremely careful in providing advice in connection with U.S. tax-related responsibilities.

U.S. Tax Classification of Selected Offshore Entities

Offshore entities labeled as corporations, partnerships, trusts, and limited liability companies under local law, which are not per se corporations, may generally choose their U.S. tax status by filing a "check-the-box election" on Form 8832. On the other hand, the default status of many potentially eligible non-U.S. entities is not always clear because some of them arguably have no exact comparable match under U.S. law. If a foreign corporation, which is a foreign-eligible entity, elects treatment as a disregarded entity or a partnership for U.S. tax purposes, the U.S. shareholders of the corporation will be subject to U.S. tax on the entity's income in the year the income is earned, regardless of whether the earnings are distributed. U.S. investors, however, are generally allowed to claim a foreign tax credit against their U.S. federal income tax liability for their pro rata share of any income taxes paid by the foreign entity to the local tax authorities. The possibility of obtaining such a credit is often of paramount importance to individual shareholders of a foreign entity located in a high-tax jurisdiction because they would otherwise be subject to double taxation, first at the corporate level, and then in the U.S. at the shareholder level. In addition, to the extent that the foreign entity incurs losses, individual or corporate U.S. shareholders may be able to reduce their U.S. taxable income using such losses.

These pass-through attributes should be compared to the possibility of deferral if "corporation" treatment is instead elected on Form 8832 or accepted as the likely U.S. default treatment of the entity, or a per se corporation is the chosen investment or business vehicle. Pass-through treatment may also avoid the application of the U.S. branch profits tax with regard to certain effectively connected earnings and profits of the foreign entity, limit the imposition of income taxes to a single level, and enable the potential availability of long-term capital gains treatment in appropriate cases. If the foreign entity is either located in a low- or no-tax jurisdiction, its earnings will be distributed to its owners on an annual or more frequent basis, or it will predominately earn income of one or more types not eligible for deferral under U.S. tax law. Electing pass-through treatment or maintaining it as the entity's default classification may be the most overall advantageous planning tool for U.S. owners of the entity.

Foreign Partnerships

Many foreign "partnership" type entities with at least two owners arguably should default as such for U.S. tax purposes without the need to file a check-the-box election. On the other hand, if ultimately advantageous from a U.S. tax collection standpoint, the IRS may instead attempt to classify the entity as a corporation or disregard it entirely for U.S. tax purposes. Under the latter circumstances, "piercing the veil" in this manner could for example increase the likelihood of the estate of a non-U.S. person individual partner being subject to U.S. estate tax upon his or her share of the entity's U.S.-situs assets.

One potential partnership-type entity "piercing" method could be that an entity has only one actual "owner" because all the owners are commonly controlled or all but one such owner has a "de minimis" interest, thereby deeming the entity assets owned directly by a single owner. For example, in Rev. Rul. 77-214, (1) a pre-check-the-box election regulation ruling, the IRS treated a German GmbH that was jointly owned by two U.S. corporations with a common U.S. parent company as a corporation for U.S. tax purposes because the U.S. parent corporation was, in substance, the entity's sole beneficial owner. Although the IRS later modified this ruling and declared it to be obsolete, it could still potentially use similar reasoning to claim that when one person or entity owns most of a partnership, with the other...