Foreign corporations investing in partnerships: common branch profits tax issues.

• Author: Karges, Martin

Foreign corporations investing in the United States through a partnership that generates effectively connected income (ECI) must file a branch return (Form 1120-F, U.S. Income Tax Return of a Foreign Corporation) and are subject to the U.S. branch profits tax (BPT). Unless reduced by an international income tax treaty, the U.S. BPT rate of 30% can become costly for a foreign investing corporation. The BPT rules under Sec. 8.84(a) generally apply to any foreign corporation that is investing in the United States through a U.S. branch, which includes an interest in a partnership earning ECI.

The following highlights some of the tax compliance challenges that often arise as a result of BPT exposure.

Background and General Overview of the BPT

The BPT is intended to achieve parity for investments in the United States through a U.S. branch or a U.S. subsidiary. While dividend payments by a U.S. subsidiary to its foreign parent corporation are generally subject to a 30% withholding tax under. Sec. 881(a), remittances of a U.S. branch to its foreign home office could escape this source tax without the BPI Sec. 884(a) imposes a 30% tax on a foreign corporation's effectively connected earnings and profits (ECE&P) that are not reinvested in a U.S. trade or business by the close of the foreign corporation's tax year, or that are disinvested in a later year (dividend equivalent amount).

The dividend equivalent amount is calculated by adjusting current-year ECE&P either upward or downward, depending on the foreign corporation's movement in U.S. net equity during the tax year. If the U.S. net equity at the beginning of the tax year was higher than at the end of the tax year, the foreign corporation is deemed to have repatriated or disinvested earnings (Regs. Sec. 1.884-1(b)(1)). U.S. net equity is the aggregate amount of U.S. assets over U.S. liabilities, whereby U.S. liabilities are generally determined under Regs. Sec. 1.882-5, and U.S. assets are the U.S. adjusted basis modified for E&P purposes (see Regs. Secs. 1.884-1(c)(2) and (d) (1)). Basis adjustments for E&P purposes could, for example, consist of depreciation adjustments to a straight-line method where an accelerated depreciation method was used for income tax purposes.

The following illustrates the dividend equivalent amount computation:

Example 1: In year 1, foreign corporation has U.S.net equity at the beginning of the year (BOY) of $5,000, end of the year (EOY) U.S. net equity of $5,100, and...