Hans, a citizen and resident of Argentina, is a retired bank executive. Hans doe

Question

Hans, a citizen and resident of Argentina, is a retired bank executive. Hans does not hold a green card. At the start of Year 1, Hans paid $2.5 million for a 20-unit apartment complex located in the suburbs of Washington, D.C. Hans does not actively manage the building, but rather leases it to an unrelated property management company that subleases the building to the tenants. During Year 1, Hans had rental income of $300,000 and operating expenses (depreciation, interest, insurance, etc.) of $220,000. On the advice of his accountant, Hans made a Code Sec. 871(d) election in Year 1. At the start of Year 2, Hans sold the building for $350,000. Hans%u2019 adjusted basis in the building at that time was $290,000.

What are the U.S. tax consequences of Hans%u2019 U.S. activities?

Explanation / Answer

1. Hans, a citizen and resident of Argentina, is a retired bank executive. Hans does not hold a green card. At the start of Year 1, Hans paid $2.5 million for a 20-unit apartment complex located in the suburbs of Washington, D.C. Hans does not actively manage the building, but rather leases it to an unrelated property management company that subleases the building to the tenants. During Year 1, Hans had rental income of $300,000 and operating expenses (depreciation, interest, insurance, etc.) of $220,000. On the advice of his accountant, Hans made a Code Sec. 871(d) election in Year 1. At the start of Year 2, Hans sold the building for $350,000. Hans%u2019 adjusted basis in the building at that time was $290,000.

What are the U.S. tax consequences of Hans%u2019 U.S. activities?

2. USAco, a domestic corporation, is a wholly-owned subsidiary of FORco, a foreign corporation. USAco%u2019s only assets are cash of $200,000, accounts receivable of $200,000 and its U.S. manufacturing plant worth $500,000. USAco has no liabilities. FORco sells USAco to an independent U.S. buyer.

Is FORco%u2019s sale of USAco subject to withholding under FIRPTA? Explain.

Would your answer change if USAco had a liability of $300,000 in the form of a mortgage on the U.S. manufacturing plant?

3. Cholati is a foreign corporation that produces fine chocolates for sale worldwide. Cholati markets it chocolates in the United States through a branch sales office located in New York City. During the current year, Cholati%u2019s effectively connected earnings and profits are $3 million, and its U.S. net equity is $6 million at the beginning of the year, and $4 million at the end of the year. In addition, a review of Cholati%u2019s interest expense account indicates that it paid $440,000 of portfolio interest to an unrelated foreign corporation, $200,000 of interest to a foreign corporation which owns 15% of the combined voting power of Cholati%u2019s stock, and $160,000 of interest to a domestic corporation.

Compute Cholati%u2019s branch profi ts tax, and determine its branch interest withholding tax obligations. Assume that Cholati does not reside in a treaty country.

4. Wheelco, a foreign corporation, manufactures motorcycles for sale worldwide. Wheelco markets its motorcycles in the United States through Wheely, a wholly-owned U.S. marketing subsidiary that derives all of its income from U.S. business operations. Wheelco also has a creditor interest in Wheely, such that Wheely%u2019s debt to equity ratio is 3 to 1, and Wheely makes annual interest payments of $60 million to Wheelco. The results from Wheely%u2019s first year of operations are as follows:

Sales ............................................................................................. $180 million

Interest income ............................................................................... $6 million

Interest expense (paid to Wheelco)................................................................................................. $6 million

Depreciation expense....................................... .............................. ($30 million)

Other operating expenses................................. .............................. ($81 million)

Pre-tax income ................................................. ............................ $15 million

5. Assume the U.S. corporate tax rate is 35%, and that the applicable tax treaty exempts Wheelco%u2019s interest income from U.S. withholding tax. Compute Wheely%u2019s interest expense deduction.

6. USAco, a domestic corporation, is the wholly-owned U.S. subsidiary of FORco, a foreign corporation. The U.S.-Country F tax treaty exempts interest payments from withholding taxes. USAco%u2019s financial statements appear as follows:

BALANCE SHEET

Assets Liabilities & Owners%u2019 Equity

Cash $100

Receivables $500

Notes Payable $400

Owner%u2019s Equity $200

INCOME STATEMENT

Gross Income $500

Administrative Expenses $350

Interest Expense $100

The interest expense of $100 arises from a notes payable from USAco to FORco.

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