Chapter 7 Solution - Unit 7 TREATMENT OF FOREIGN-OWNED...

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Unit 7 TREATMENT OF FOREIGN-OWNED UNITED STATES INVESTMENT INCOME A. CODE AND REGULATION PROVISIONS Code §§ 871(a), (d), (h), (i); 873(a), (b); 881(a), (c), (d). Reg. § 1.871-7. B. PROBLEMS FOR CLASS DISCUSSION 7-1. Surya, a citizen and bona fide resident of Nepal, has never been present in the United States. During Year 1, he had no United States trade or business, but he owned a number of assets that produced the following items of income: $20,000 dividend on the stock of DelCo, a corporation formed in Delaware; $5,000 gain on sale of 10 shares of stock in UruCo, a corporation formed in Uruguay; $13,000 dividend on the UruCo stock, of which $5,200 is United States source and $7,800 is foreign source; $10,000 in rents from rental property located in the United States; $1,000 of foreign-source interest on a loan made to Emily, a citizen and resident of Bolivia; $2,000 of interest on a deposit at a Chicago, Illinois bank; and $8,000 in cash from the sale of the United States rights to a patent Surya created for 5 percent of the net profits from products produced through its use. 7-1. Surya’s potential deductions for the year consisted of depreciation and expenses with respect to the rental property of $3,000, a $1,000 loss on the sale of five shares of UruCo stock, and medical expenses incurred abroad of $4,500. Assume that Surya would be subject to a 20 percent effective tax rate on his taxable income if §§ 1 and 55 applied. (a) What is Surya’s United States taxable income and his tax liability for Year 1? (a) TAXABLE INCOME $38,000; TAX LIABILITY $11,400. Non-resident individuals are generally taxed under § 871(a) at a 30 percent rate of tax on certain United States source types of income and under § 871(b) at the graduated rates of § 1 on income effectively connected with a domestic trade or business. Section 871(b) does not apply where no trade or business exists, as in this problem, so the applicable provision here is § 871(a). (a) Section 871(a)(1)(A)–(D) lists types of income that are subject to a 30 percent tax if received by a non-resident individual. Only income items “received from sources within the United States” and not effectively connected with a United States trade or business are subject to tax under § 871(a)(1). As a result, tax is not imposed on the items listed under § 871(a)(1) if they are foreign-source. Surya has two such items: the $7,800 UruCo dividend and the $1,000 interest payment from Emily (sourced under §§ 861(a)(1) and 861(b) based on the payor’s residence). Since the dividend (stipulated as foreign source) and interest are not “received from sources 33
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within the United States,” § 871(a)(1) does not apply and no tax will be imposed on these items. (a) Regarding the royalties received from the patent, an initial issue arises as to whether the transaction is a sale or a license. However, regardless of its classification, it will be taxed at 30 percent. If properly classified as royalties, it will be subject to the 30 percent rate of tax given its domestic source. If instead the transaction is properly classified as a sale, given the contingent consideration, it is sourced as royalties under § 865(d)(1)(B). Due to its use in the
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