State and local tax considerations for inbound foreign entities.

• Author: Alajbegu, Jim

Foreign entities not engaged in a U.S. trade or business, not deemed to have a permanent establishment, or that have claimed a federal treaty exemption may still be subject to state and local income taxes. The term "U.S. trade or business" is not defined in the Code or Treasury regulations. The standard for determining whether a foreign entity is engaged in a U.S. trade or business is subjective and is generally satisfied if the foreign entity is engaged in a sustained activity in the United States for a substantial portion of the tax year.

It should be noted that the IRS has historically taken a very restrictive view of the amount of activities that may be carried on without creating a U.S. trade or business. Specifically, any activities beyond the mere receipt of income from property and the payment of organization and administration expenses incidental to the receipt and distribution thereof will constitute the conduct of a U.S. trade or business by a foreign corporation. A foreign entity that is entitled to treaty

benefits and maintains a U.S. permanent establishment is subject to U.S. tax only on business profits that are attributable to the permanent establishment.

A state's ability to impose an income, franchise, or gross receipts tax on a foreign entity is not dictated by any federal limitations unless a state voluntarily enacts implementing legislation adopting similar limitations. Each state may implement its own set of rules, resulting in complexity for foreign entities operating in multiple states.

Nexus

If a state has not adopted any tax limitations similar to those the foreign entity relies upon from a federal perspective, the foreign entity is generally taxable if nexus has been established with the state. Historically, a physical presence was required to establish nexus resulting in a requirement to file income, franchise, or gross receipts tax returns. Further, under most U.S. tax treaties, a U.S. corporation or a foreign corporation is treated as having a permanent establishment in the other contracting state only if (1) it maintains a fixed place of business in the United States or (2) the activities of another person who maintains such a fixed place of business are imputed to the foreign corporation. However, over time, states have become increasingly creative in establishing nexus with theories such as economic nexus and factor presence.

The economic nexus theory targets companies without a physical presence but that...