Foreian fees: navigating complex rules regarding fees paid by U.S. entities.

• Author: Barragato, Charles A.
• Position: Corporationtax

The nature and amount of fees paid bv U.S. entities to foreign persons has gained greater attention in recent years. Foreign persons include aliens who do not reside in the United States [Internal Revenue Code Sec. 881(b)(2)], and foreign corporations are defined as those organized under the laws of a foreign country or U.S. possession [Sec. 7701(a)(5)]. In this article, we'll assume the recipient of the fees is a foreign corporation.

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A foreign corporation is not subject to taxation bv the United States on income that is neither from U.S. sources nor connected with a business entity conducting operations in the United States. This exemption is justified for foreign corporations owned by foreign persons. However, questions arise when U.S. citizens or U.S. domestic corporations own foreign corporations either partially or wholly. An example of this ownership structure is a foreign subsidiary of a domestic corporation.

Complex rules that define and govern foreign personal holding companies, controlled foreign corporations, passive foreign investment companies and foreign sales corporations have been adopted to prevent the avoidance or significant deferral of U.S. taxation of income beneficially owned by a U.S. person. In addition, rules were implemented with respect to transfers to and from foreign corporations to recognize the special status of foreign corporations in which U.S. persons have an ownership stake (sees. 951-971).

A number of interrelated IRC sees, must be considered when payments are made for fees by U.S. entities to foreign persons. The first set of sections to note deals with income sourcing and whether fees paid are effectively connected with a U.S. trade or business.

The applicability of this rule is based on the facts and circumstances. If all of the services take place outside of the United States, and there is no connection to the United States through imputation or otherwise, then the income should not be considered sourced to the United States.

Identifying potentially imputed activities in this area is important. In most cases, the activities of agents, including entities such as partnerships, trusts and estates, will be imputed to the foreign corporation. Also, activities by persons subject to a high degree of control by the corporation, including employees, will be imputed to the foreign corporation.

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