Gross income comes from following categories of income:
Interest, Dividends, Personal Services, Rentals, Royalties, Gains from disposition of property.
Leasing generates rental income. It belongs to the rental of property and where it is located. Installment sales yield gain on the sale of a property. Installment sales also yield interest income.
Categorization of income items can give different results between U.S source income and foreign source income.
Income related to a computer software or a computer program can be treated in different ways like:
Transfer of copy right.
Transfer of a copy righted article.
Services for modification of a computer program.
A provision of know how relating to computer programing.
Example:
Mr. A is a singer. A U.S based recording company hired the singer and made an album in which Mr. A teaches singing. Mr. A gets a percentage of sales of album. Commissions that Mr. A gets from the sale of albums in the United states is treated as personal services income from the U.S. Commissions that Mr. A gets from the sales of album in foreign countries is teated as foreign source if it is treated as royalty income.
Following table (from the book U.S taxation of international transactions by Robert J. Misey, Jr. And Michael S. Schadewald) explains the general rules for sourcing gross income:
| Type of Income | U.S source income if: | Foreign source income if: |
| Interest income | Debtor is a U.S resident or a domestic corporation | Debtor is a foreign resident or a foreign corporation |
| Dividends | Payer is a domestic corporation | Payer is a foreign corporation |
| Personal services income | Services are performed in U.S. | Services are performed in a foreign country |
| Rentals and royalties | Property is used in U.S | Property is used in a foreign country |
| Gains on sale of real property | Property is located in U.S | Property is located in a foreign country |
| Gain on sale of personal property | Seller is a U.S. resident | Seller is in a foreign country |
| Income from the sale of inventory purchased for resale | Title passes in U.S | Title passes in a foreign country |
| Income from the sale of inventory manufactured by taxpayer | Allocate between U.S. and foreign source income using the 50-50 method | |
| Gain on sale of depreciable property | Title passes in U.S. | Title passes in foreign country |
| Gain on sale of patents and other intangibles | Seller is a U.S resident | Seller is a foreign resident |
Interest Income:
If a domestic corporation pays interest it is U.S source income.
Interest paid by U.S government is a U.S source income.
Interest paid by one of the 50 states or District of Columbia is U.S source income.
Interest paid by a U.S branch of a foreign corporation is treated as if it were paid by a domestic corporation. So it will be treated as U.S source income and subject to U.S withholding tax.
If a foreign corporation pays interest it is a foreign source income.
Interest received from deposits made with a foreign branch of domestic corporation or partnership engaged in commercial banking business is treated as foreign source income.
U.S resident taxpayers:
Individuals who, at the time the interest is paid, are residents of the United states.
Domestic corporations.
Domestic partnerships which at anytime during the taxable year were engaged in a U.S trade or business.
Foreign corporations or foreign partnerships which at any time during the taxable year were engaged in a U.S trade or business.
Dividend Income:
Dividends paid by domestic corporations are U.S source income.
Dividends paid by foreign corporations are considered foreign income.
If a foreign pays dividends that has 25% or more of its gross income from conduct of U.S trade or business in the past three years, it will be considered U.S source income. The U.S source portion will be equal to the amount of dividends times the ratio of the foreign corporation’s gross income that was effectively connected with the U.S trade or business during the three years testing period and foreign corporation’s total gross income.
If a foreign corporation is owned 50% or more by the U.S persons and it pays dividends attributable to U.S source income, it will be considered U.S source income.
A domestic corporation that claims a dividends received deduction with respect to a portion of a dividend from a foreign corporation must treat that portion of the dividend as U.S source income for purposes of computing the foreign tax credit limitation.
Personal Services Income:
Income earned by providing services in the United Sates is U.S based income.
Income earned by providing services in a foreign country is foreign source income.
Non residents who stay in U.S for 90 or less days and earn services income, it is considered foreign source income.
If a non resident alien receives $3,000 or less for his services performed in U.S his income is considered foreign source income.
A non resident alien who works as an employee or under contract for a foreign person who is not engaged in a U.S trade or business, or for the foreign office of a U.S person, his earnings are treated as foreign source.
Rental and Royalty Income:
Rental and royalty income earned from the property located in U.S are U.S income.
Rental and royalty income earned from the property located in a foreign country is treated as foreign income.
Income from disposition of property:
If a property located in the U.S is sold at gain, such gain is treated as U.S based income.
If a property located in a foreign country is sold at gain, such gain is treated as foreign income.
Who are U.S residents?
A domestic corporation.
A U.S citizen or resident alien who does not have a tax home in a foreign country.
A non resident alien who has a tax home in the United States.
A trust or estate whose situs is in the United States.
If a U.S citizen or resident alien has a tax home, a fixed place of business or an office in a foreign country and he realizes a gain on sale of his property, such gain is treated as foreign income. Gain must be subject to foreign tax at a rate of at least 10%.
If a taxpayer purchased inventory for resale and sells it in the U.S, his income will be considered U.S income. If the sale occurred in a foreign country, income will be considered foreign income. Place of sale is usually determined where title of the goods passes from seller to buyer.
If a taxpayer produces inventory in the United States and sells it in a foreign country, income is apportioned between U.S and foreign source using one of the following methods:
50 – 50 method.
The independent factory price method.
Taxpayer’s books and records.
Most of the time taxpayers are required to use 50 – 50 method. Using this method, a U.S manufacturer will apportion 50% of the gross income from export sales and 50% based on production activity.
If a non resident maintains an office or a fixed place of business in the United States and earns income from sale of personal property in the United States (including inventory), his income is treated as U.S source income.
Depreciation reduces basis of a property. When a taxpayer sells such property it will increase his gain. If prior depreciation deductions offset U.S source and foreign source income its recapture is allocated between U.S and foreign source income in the same proportion as prior deductions. Any appreciation after recapture is sourced using applicable inventory rules. It means gain is sourced based upon where title of property passes from seller to buyer.
Patents, copy rights, secret process or formula, good will, trade mark, trade brand, franchise or other like property are all examples of intangible assets. Gain on disposition of intangibles is attributable in whole or in part to prior amortizations. Gain that is attributable to prior deductions of amortization is considered having same source as the related deductions that are determined under the same tracking rules that apply to depreciation of tangible property.
Gain attributable to appreciation of intangible is sourced using the residence of seller rule.
If the sale of intangible is based on its use or disposition it is sourced as if it were royalty payment. Royalties are sourced based on the location of the actual use or the right to use of the intangible.
A gain on the sale of goodwill is sourced with in the country in which the goodwill arises.
A gain on sale of stock of a domestic company is treated as U.S source income.
A domestic corporation can treat gains from sale of stock of a foreign affiliate as foreign source income if it meets following conditions:
The domestic corporation owns 80% or more of the affiliate foreign corporation.
The sale of stock happens in a foreign country in which affiliate is engaged in the active conduct of a trade or business.
More than 50% of the gross income was derived from the active conduct of a trade or business in foreign country.
Special source of income rules apply to dispositions of non functional currency, debt instruments, receivable, payable, futures and option contracts. These transactions are referred to as section 988 transactions.
Foreign currency transactions are sourced based on residence of the taxpayer or the qualified business unit of the taxpayer in whose books assets, liabilities, income and expenses are recorded.
Different rules will apply to remittances made by branch office. If a branch office remits payments in a currency different from the U.S dollar, the U.S parent must recognize a foreign currency gain or a loss that equals to the difference between the U.S dollar value of the remittance and the U.S parent’s basis in the branch’s accumulated earnings. Any gain or loss is sourced with reference to the source of income which will rise to branch accumulated earnings.
Insurance earnings are sourced on the basis of where the risk of insured is located.
Premiums that relate to property located in the United States, or a liability arising out of an activity in connection with the lives or health of residents of the United States is treated as U.S source income.
U.S source insurance income also includes income from issuing risks located outside the United States and as a result a corporation receives premiums for issuing risks located with in the United States.
Disclaimer:
This information is for educational purposes only. It does not constitute any legal advice or opinion. Please do not use any of its contents without seeking a professional advice.
References:
www.jct.gov/publications.html
http://www.law.cornell.edu
http://www.irs.gov/publications
U.S Taxation of International Transactions by Robert J. Misey, Michael S. Schadewald
Introduction to United states International Taxation by Paul R. McDaniel, Hugh j. Ault and James R. Repetti
International Taxation by Joseph Isenbergh
International Taxation in a nutshell by Richard L. Doernberg.
International Income Taxation, Code and Regulations by Robert J. Peroni – CCH
Mansoor Suhail (Mani)
Accountant
BSBA – EA – ICIA – RA
Tax for Canada and U.S.A
Web: www.theaccountingandtax.com and www.taxservicesguru.com Blog: http://taxservicesguru.blogspot.ca
416 – 283 – 8774