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Final branch profits regulations.

The IRS issued final regulations for the branch profits tax (Internal Revenue Code section 884). The new regulations, effective for tax years beginning on or after October 13, 1992, replace temporary regulations issued in September 1988.

Added as part of the Tax Reform Act of 1986, the branch profits tax generally imposes a 30% tax on earnings by a foreign corporation's U.S. branch to the extent the earnings are not reinvested in assets connected with a U.S. trade or business.

Foreign corporations may obtain rate reductions or exemptions from the tax if there is an income tax treaty between the United States and the corporation's home country. The corporation, however, must meet at least one of three tests proving it is a "qualified resident" of the relevant foreign country. Some of the requirements for satisfying these tests are liberalized under the new regulations.

For example, the "stock ownership and base erosion test" requires more than 50% of the stock of the foreign corporation to be beneficially owned by residents of either the corporation's home country or the United States.

Although certification generally is required to verify residency, the final regulations provide that if a corporation has at least 250 individual shareholders, residency certificates are not required from shareholders who own less than 1% of the corporation's stock.

Under the "publicly traded test," the temporary regulations required 30% of the stock to be traded annually on established securities markets in either the country of residence or the United States. The final regulations adopt rules contained in IRS notice 89-80 that lower this turnover requirement to just 10%.

In addition, under the earlier regulations this test could not be met if 100 or fewer persons owned more than 50% of the corporation's stock. Under the final regulations, however, a corporation will be disqualified from the test only if 50% or more of its stock is beneficially owned by one or more 5% shareholders who do not meet the residency qualifications.

The "active trade or business test" requires the foreign corporation to have an active and substantial business in its country of residence and that the trade or business giving rise to income for which a treaty benefit is claimed be an integral part of the business in the home country. Ratios are established comparing worldwide assets, gross income and payroll with those generated in the corporation's home country.

In order to benefit certain trading companies that would otherwise have difficulty meeting the gross income ratio, the final regulations allow many foreign corporations to use an alternative ratio formula comparing direct material costs for tangible property produced in the home country to the total direct material costs of the foreign corporation.

Observation: The final regulations make it easier for legitimate residents of foreign countries to comply with requirements to obtain treaty benefits. However, the new regulations still leave little room for "treaty shopping."

Edited by Andrew R. Biebl, CPA, Biebl, Ranweiler & Co., New Ulm, Minnesota (small business); Robert Willens, CPA, senior vice-president at Lehman Brothers, New York City (corporate); Marianne Burge, CPA, director of international tax services, Kenneth Kral, CPA, international tax partner, and Jack Serota, Esq., international tax consultant, at Price Waterhouse, New York City (international).
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Publication:Journal of Accountancy
Date:Dec 1, 1992
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