The US Tax Effects Of Choice Of Entities For Foreign Investment - IIR

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or a domestic corporation or a governmental unit.” 23 Under Treas. Regs. § 301.7701-5, a partnership is deemed to be a resident of the United States whenever it is engaged in a U.S. trade or business, regardless of where it is formed. Thus, Treas. Regs. § 20.2104-1(a)(4) could be read as saying that interests in partnerships (assuming such interests are “intangible personal property the written evidence of which is not treated as being the property itself”) are U.S. situs if issued by a partnership that is engaged in a U.S. trade or business (and, therefore, is a U.S. “resident” partnership). 2. Why Treas. Regs. § 20.2104-1(a)(4) is Invalid if it Purports to Create a U.S. Trade or Business “Residence” Test for Determining Situs of Intangibles Not Covered by the Basic Statutory and Regulatory Rules. As noted above, when the original “catch-all rule” for otherwise uncovered intangibles was adopted by the 1934 Treasury Regulations, the “physical presence test” was the predominant situs rule for all intangibles other than shares issued by U.S. corporations. During this same period, there were dicta in some otherwise authoritative cases that suggested that the physical presence test for the situs of intangibles might also be met if the foreign entity (whose equity interests were being tested) was itself engaged in a U.S. trade or business. For example, in Farmers’ Loan & Trust Co. v. Minnesota, 24 the U.S. Supreme Court observed that “[cites omitted] recognize the principle that choses in action may acquire a situs for taxation other than at the domicile of their owner if they have become integral parts of some local business [but the] present record gives no occasion to inquire whether such securities [should be so treated].” 25 Similarly, in Sanchez v. Bowers, 26 , after already finding that the “sociedad de gananciales” (a juridical entity under the then applicable Cuban law) was deemed liquidated upon the death of Sanchez (such that the underlying securities which the sociedad de gananciales had maintained in New York were U.S. situs under the physical presence test), Justice Learned Hand went on in dicta (indicating that he was applying the ratio decidendi of Farmers’ Loan & Trust Co. v. Minnesota) to speculate as follows: “It may be that a foreign corporation by its activities can also so subject itself to the power of Congress as to be ‘present’ as obligor, for the purpose of taxing the devolutions of its shares or debts, just as it may make itself ‘present’ for personal judgment. In that event the question here would be how continuously and substantially Sanchez carried on the ‘business’ of the ‘sociedad de gananciales’ in New York. If his [the sociedad de gananciales] activities were enough, his individual estate could be made liable for the devolution of some part of his dividend in liquidation, which is all we are holding it for anyway.” 27 Based on the research of the author and his colleagues, Sanchez v. Bowers appears to come closest to articulating (albeit in a pure dicta context) the concept that a business presence of a foreign entity might be sufficient to cause the equity interests in the foreign entity to be deemed physically present in the United States under the then applicable physical presence test for determining situs of intangibles. However, several points are critical. First, neither Farmers’ Loan & Trust Co. v. Minnesota nor Sanchez v. Bowers, in fact, come to the conclusion that a business presence of a foreign entity is sufficient to cause its equity interests to be deemed “present” in the jurisdiction (outside of its country of incorporation) where it is engaged in a trade or business for U.S. estate tax purposes, and certainly there is nothing in either decision to suggest that such a rule, if adopted (which it was not), should apply when the foreign entity is 23 Treas. Regs. § 20.2104-1(a)(4). Emphasis added. Quite importantly, this subparagraph starts off by stating “Except as specifically provided otherwise in this section or in § 20.2105-1 (which specific exceptions, in the case of decedents dying on or after November 14, 1966, cause this subparagraph to have relatively limited applicability).” Emphasis added. 24 280 U.S. 204 (1930). 25 Id at 213. 26 70 F2d 715 (2d Cir. 1934). 27 Id at 718. Emphasis added. 6
only deemed to be engaged in a U.S. trade or business (as would be the case when a second-tier partnership holds an interest in a lower-tier partnership that is engaged in a U.S. trade or business only because of the artificial attribution rule of Code § 875(1)). Second, the case law illustrates that there is no stand-alone “U.S. trade or business of a foreign entity causes its equity interests to be U.S. situs” rule. To the contrary, it is evident from a careful review of the discussions in the pertinent case law, that the idea of a U.S. trade or business having any impact on the situs of an intangible only came into speculative possible application in the context of deciding whether the intangible had sufficient nexus with the United States to be deemed “present” under the then applicable “physical presence test.” In other words, the consideration of whether a U.S. trade or business should be taken into account was only a potential sub-analysis under the “physical presence test”—it was never a stand alone test adopted and applied by any U.S. federal court in the U.S. estate tax context. Thus, to the extent that the catch-all situs rule for intangibles first included in the 1934 Treasury Regulations purported to adopt a “U.S. trade or business test” when referring to whether an intangible interest was issued by or enforceable against a “person who is a resident of the United States,” then it obviously was already making an extension of the case law that the courts had not adopted or applied (nor did the courts ever do so subsequently). On the other hand, given the seemingly significant sweep of the U.S. Supreme Court’s decision in favor of the physical presence test in Burnett v. Brooks and the seemingly supportive dicta of Justice Learned Hand in Sanchez v. Bowers (quoted above), the introduction of such a “U.S. trade or business” test for determining physical presence in a catch-all rule might have seemed like a reasonable extension of the then evolving precedents in the early 1930s. However, as we shall see, what arguably might have been a reasonable extension of the statutory and judicial precedents in 1934 when the “physical presence test” was at its peak and what is a reasonable statutory interpretation today when the physical presence test effectively has been repealed are two entirely different stories. Starting in at least 1958 and ending in November 1966 with the enactment of the Foreign Investors Tax Act of 1966, the “physical presence test” was abandoned and replaced by situs rules that turn on where the underlying entity is organized, regardless of whether engaged in a U.S. trade or business and where the physical certificates may be held. By 1958, the Treasury Regulations had already been amended to provide that shares in a non-U.S. corporation would be classified as a non-U.S. situs asset, mirroring the long-standing rule that U.S. corporate shares were always U.S. situs. This, of course, was a retreat from the physical presence test and the holding in Burnett v. Brooks that the non-U.S. shares involved therein were U.S. situs because they were physically maintained in the United States at the time of the decedent’s death. The last remnants of the physical presence test were eliminated by the Foreign Investors Tax Act of 1966, and the Treasury Regulations were amended to provide the new test for “the written evidence of intangible personal property which is treated as being the property itself, such as a bond for the payment of money” no longer would depend on the physical presence of such intangibles. 28 As a result, since 1966, we have ended up with the principal situs rules providing (i) that real and tangible personal property are sitused based on where physically located and (ii) that stocks and bonds are sitused based on the place of incorporation of their issuer or obligor, with no consideration of where such entities are engaged in trades or businesses or where the physical certificates of such corporate entities are held. Thus, if the catch-all intangible situs rule today is intended to be simply analogous to the principal entity situs rule that turns on the place of incorporation of the issuer or obligor, then it would be a logical extension of the principal corporate intangible situs rule and one might accept that such a rule’s application to a partnership interest should be that (a) if the partnership is formed in the United States, then its interest will have a U.S. situs, whereas (b) if the partnership is organized outside the United States, its interests are non-U.S. situs. On the other hand, if the continuing reference to a 28 Treas. Regs. § 20.2104-1(a)(3). 7
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Page 3 and 4: a. Applicable Rates and Taxable Ass
Page 5: might sustain such an IRS position,
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Page 11 and 12: C. U.S. Income Taxation of the Disp
Page 13 and 14: gain under §865(e)(2) because the
Page 15 and 16: determining the source and characte
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Page 19 and 20: income must be determined at the pa
Page 21 and 22: corporate structural options for in
Page 23 and 24: Absent use of appropriate financing

The US Tax Effects Of Choice Of Entities For Foreign Investment - IIR

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