USA Law and Practice Contributed by: Devon M Bodoh, Joseph M. Pari and Blake D. Bitter, Weil, Gotshal & Manges LLP
ic nature of the cross-border activity; and, depend - ing on the adjustments, a penalty can be imposed on an underpayment of taxes that results from improper management and administrative expenses incurred. 5.7 Restraints on Related-Party Borrowing The Code and tax regulations contain rules that broadly impact on the tax treatment of certain relat - ed-party debt issued by US corporate borrowers to certain related parties (including non-local affiliates) (Debt Recast Rules). Generally, the intention of these rules is to prevent erosion of the US tax base through placement of debt owed by a US corporation to a foreign affiliate; and, if applicable, they have the effect of recharacterising certain related-party debt as equity to eliminate US tax deductions on interest payments. The Debt Recast Rules generally apply to debt issued in connection with certain enumerated transactions (Specified Transactions). Specified Transactions include: • distributions within an expanded group; • asset acquisitions from within the expanded group; and • stock acquisitions within the expanded group. In addition, the Debt Recast Rules also contain certain presumptions (such as related to the per se funding rule) that further expand the scope and applicability of the Debt Recast Rules. While the Debt Recast Rules are exceedingly complex, it should be noted that they contain many material exceptions that can mitigate or prevent the applicability of such rules in a broad range of cases. 6. Taxation of Foreign Income of Local Corporations 6.1 Foreign Income Exemptions The USA taxes its citizens and residents (including domestic corporations) on their worldwide income directly earned from whatever source derived, which is generally taxed at a 21% rate (see 1.4 Applicable Corporate and Individual Tax Rates ). As described in later sections (see 6.3 Dividends From Foreign Subsidiaries ), a special set of rules applies to income
earned through a foreign subsidiary. That said, the USA generally permits an FTC (or deduction) against US income tax for taxes that are properly paid to other countries on income sourced to such other countries (see 2.3 Special Incentives ). In addition, US taxpayers are generally permitted to utilise foreign losses to offset US-source income sub - ject to certain recapture rules (see 6.2 Non-Deducti- ble Local Expenses ). The USA’s “worldwide” system of taxation is in stark contrast to many foreign juris - dictions that impose a territorial tax regime, which generally excludes (or exempts) the profits earned by non-local companies. 6.2 Non-Deductible Local Expenses The USA generally taxes US persons on their world - wide income, including their foreign taxable income. If a taxpayer’s losses (including deductions and expens - es) from foreign sources exceed its foreign-source income, the excess, which is referred to as an overall foreign loss, can be used to reduce US-source income and, as such, the effective rate of tax on such income. In a subsequent year, however, the full allowance of an FTC may result in a double-tax benefit. To eliminate this benefit, foreign losses (claimed in a prior year) are recaptured by treating a portion of the foreign-source income in the later year as US-source income. 6.3 Dividends From Foreign Subsidiaries When a CFC makes a distribution to its US sharehold - er, the nature and character of that distribution must be determined. Specifically, whether the CFC has any E&P must be determined, as must the character of the E&P. If E&P exists, a distribution is generally sourced from the CFC in the following order: • previously taxed E&P (PTEP) (ie, the E&P of a CFC attributable to income that has already been included in the gross income of a US shareholder); • not previously taxed E&P (non-PTEP) (ie, the E&P of a CFC that has not been included in a US share - holder’s gross income); • return of capital; and • capital gain. Generally, PTEP distributions are excluded from a shareholder’s gross income. However, a US share -
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