Exceptions to branch profits tax available to foreign corporations with U.S. tax compliance obligations.

• Author: Barsuk, Katherine

Sec. 884(a), enacted as part of the Tax Reform Act of 1986, RL. 99-514, imposes a branch profits tax on the effectively connected income (ECI) of a U.S. branch of a foreign corporation when those earnings are repatriated, or deemed repatriated, to the home office of the branch. Sec. 884 was enacted with the legislative intent of eliminating any disparate tax treatment between U.S. corporate and flowthrough subsidiaries of foreign corporations when there are actual or deemed outbound distributions of the earnings from those U.S. subsidiaries to foreign corporate parents.

In certain situations, a branch profits tax may also be imposed on gain derived from certain direct or indirect dispositions of assets of a foreign corporate parent, which may result in the unintended double taxation of income of foreign persons. This item addresses certain limited exceptions to branch profits tax liability pursuant to Sec. 897, as enacted by the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA), PL. 96-499, and the branch termination exception of Temp. Regs. Sec. 1.884-2T, of which every foreign taxpayer and tax adviser should be aware.

Branch Profits Tax Generally

Unless otherwise provided for in the Code and Treasury regulations, each foreign corporation doing business in the United States through a branch (or entity otherwise treated as a flowthrough for U.S. tax purposes, such as a partnership) is generally subject to tax on a net basis at graduated tax rates on income effectively connected with a U.S. trade or business (branch) pursuant to the rules outlined in Sec. 882. In addition, unless reduced or exempted by an applicable tax treaty, a 30% branch profits tax is imposed on after-tax effectively connected earnings and profits of a foreign corporation's U.S. trade or business that are deemed to be distributed by the branch out of the United States under Sec. 884. The branch profits tax is imposed on the dividend equivalent amount (DEA), which are the after-tax effectively connected earnings and profits (ECEP) that are not reinvested in the United States and are deemed to have been effectively distributed out of the U.S. branch. The Treasury regulations prescribe specific procedures to determine a corporations DEA.

As a first step, the ECEP is calculated pursuant to Sec. 884(d). ECEP is defined, under Regs. Sec. 1.884-1(f)(1), as certain earnings and profits that are attributable to ECI, subject to certain earnings and profits adjustments, limitations, and exemptions.

Next, the corporation determines whether its U.S. net equity has increased or decreased during the year. U.S. net equity is the difference between the adjusted basis of U.S. assets that produce ECI, as determined under Regs. Secs. 1.884-1(c)(2) and (d)(1), and effectively...