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The Interstate Income Act of 1959, also known as Public Law 86-272, is a United States statute that allows a business to go, or send representatives, into a state to solicit orders for goods without being subject to a net income tax.
Nexus is created for income tax purposes if an entity derives income from sources within the state, owns or leases property in the state, employs personnel in the state in activities that exceed "mere solicitation," or has capital or property in the state. The requirements vary from state to state.
“Generally refers to accounts in financial institutions and companies that have had no activity generated or contact with the owner for one year or longer.”
National Association of Unclaimed Property Administrators
The various state unclaimed property administrators estimate that businesses currently have a compliance rate of only 20%
An analysis completed in 2005 revealed over 20 billion dollars of unclaimed property in state coffers. Only 20% is ever returned to the rightful owner.
> Customer overpayments and credit balances> Payroll checks to employees> Gift certificates and cards> Credit memos> Tangible personal property under a custodial arrangement,
e.g., safe deposit box> Dividend checks to shareholders> Interest checks to bondholders
There are over 100 categories of “escheatable” property
No statute of limitations Audits are generally multi-state Third party auditors paid on commission Lack of uniformity among states Large penalties and interest rates No administrative appeal Burden of proof is on the property holder NO NEXUS STANDARDS
Not inherently exempt from tax Does the physical presence test still apply? New York’s “click through” nexus law and
litigation
Amazon.com presumed to be vendor required to collect sales tax on sales when it entered into commission agreements with internet “affiliates” or aggregators that referred potential NY customers to it for a commission.
> “Click-Through” Nexus Nexus established through business relationship
between retailer and internet affiliates/aggregators Sales referred directly or indirectly via a link on
affiliates/aggregators website In-state customers “click through” to seller Must have a commission or similar agreement Active solicitation by affiliate/aggregator - “rebuttable
> New product development> New process development> New line development> New molds and new layouts> Certain trials/laboratory experimentation> Process optimization or cost reduction> Just about anything leading to a patent or certification> Design engineering applicable to multiple customers> Determining technical and functional specifications > Modeling, simulation, or testing to validate design
> General and administrative activities> Non-technical managerial functions> General sales and marketing activities> Budgeting and scheduling> Financial and cost analysis> Service and installation> Travel time> Activities conducted outside of the U.S.
Equal to 9.00% of the lesser of: qualified production activities income or taxable income
Is a permanent deduction, not a credit
Qualifying Activities if performed in the U.S.:• Manufacturing, growing, extracting, producing tangible
property• Construction activities• Engineering or architectural services for US projects
Possibility of missed deductions or allocation methodologies for companies not limited by taxable income (i.e., software development, engineering and construction)
Certain U.S. filing requirements of Canadian entities
> In order to take a position that a treaty modifies U.S. tax law, a foreign corporation is required to disclose that position by making certain filings with the IRS
> Definition of engaged in trade of business
> This is a facts and circumstances determination
> The courts have looked at the level of the foreign person's actions in the U.S. to determine whether the person is engaged in a “trade or business,” i.e. , the extent to which the actions are considerable, continuous and regular
Certain U.S. filing requirements of Canadian entities
> A foreign person holding substantial real estate in the U.S. was engaged in a U.S. business where its agent's management activities were considerable, continuous, and regular
> Holding board of director meetings in U.S. was not the operation of a business in the U.S.
> Collecting income from investments and sporadic sales was not the conduct of a business (single isolated transaction was not a business)
Certain U.S. filing requirements of Canadian entities
> General factors to consider:
- What activity does the foreign corporation have in the U.S.? Part of active business Percentage in relation to total sales Continuous and regular (i.e., not isolated, casual or occasional
transaction)
- Did corporation engage a dependent agent to conduct activity in U.S.?
- If independent agent has been engaged, what are the extent of his activities, and are they continuous and regular, percentage, etc?
Certain U.S. filing requirements of Canadian entities
> Activities of persons subject to a high degree of control by the relevant foreign person, such as employees and so-called “dependent” agents acting exclusively or almost exclusively for an entity, are properly imputed to it
> Even activities of independent agents have sometimes been imputed to foreign persons if the relationship between the independent agent and the foreign person is characterized by some degree of regularity
Certain U.S. filing requirements of Canadian entities
EXAMPLE: Sales Through a U.S. Person
Foreign Corporation retains a U.S. commission merchant and instructs it to attempt to sell its turpentine to retail hardware stores. On a regular basis, the merchant solicits orders from U.S. purchasers and remits them to Foreign Corporation in France which fills the orders and ships the product to the U.S. customers. During the course of the taxable year it sells 200 barrels of turpentine. No single order is larger than 6 barrels.
The activities of the U.S. commission merchant are most likely imputed to Foreign Corporation for purposes of determining whether it is engaged in a trade or business in the United States for that taxable year.
Certain U.S. filing requirements of Canadian entities
EXAMPLE: Agent with Exclusive Rights
Foreign Corporation manufactures devices in its home country for sale in the United States. It ships them to a warehouse located at a U.S. port. The devices are sold from the warehouse by a factory representative who has exclusive sales rights to sell them in the United States, and who is paid a commission.
The factory representative's activities are imputed to Foreign Corporation for purposes of determining whether it is engaged in a trade or business in the United States.
Certain U.S. filing requirements of Canadian entities
> An important distinction is whether a relationship is a principal-agent relationship at all, as opposed to a purchaser-seller relationship
> If a foreign person sells goods to a U.S. person for independent resale, the U.S. purchaser is not the agent of the foreign person
> Likewise, if a U.S. person sells goods to a foreign person for independent resale by the foreign person, the U.S. person is not an agent for the foreign person. This may be the case even if the U.S. person arranges to have the goods shipped directly to the foreign person's customers
> An important element of this distinction is the economic independence of the two legs of the transactions, including that a genuine purchaser takes on the economic risk of loss of the goods
Certain U.S. filing requirements of Canadian entities
> If engaged in a trade or business in the U.S., then effectively connected income has to be reported on Form 1120-F
> If a foreign corporation has a U.S. trade or business during the taxable year, whether the income is effectively connected depends upon the source of that income, it’s character, and whether the foreign corporation has an office or other fixed place of business in the U.S.
> All effectively connected trade or business income is subject to regular U.S. graduated income tax rates, the alternative minimum tax rates, the environment tax, or the alternative capital gains tax
Certain U.S. filing requirements of Canadian entities
> All U.S. source income, except for certain capital gains and fixed, determinable, annual or periodic (“FDAP”) income, is treated as effectively connected income
> Capital gains and FDAP income may be effectively connected depending upon their relationship to the foreign corporation's U.S. activity
> If the foreign corporation has a U.S. trade or business that operates from an office or other fixed place of business in the U.S., then certain foreign source income, as well as U.S. source income, will be treated as effectively connected income
Certain U.S. filing requirements of Canadian entities
> Permanent Establishment
- U.S.-Canada Income Tax Treaty
Under the treaty, the business profits of a resident of a State are taxed only in that State unless the resident carries or has carried on business in the other State through a permanent establishment situated in the other State in which case the business profits of the resident may be taxed in the other State but only so much of them as is attributable to that permanent establishment
Certain U.S. filing requirements of Canadian entities
> Under the U.S.-Canada treaty, a “permanent establishment” is a fixed place of business through which the business of a resident of a State is wholly or partly carried on
> The term includes: a place of management, a branch, an office, a factory, a workshop, a mine, an oil or gas well, a quarry, or any other place that removes natural resources
> A building site, construction or installation projects a permanent establishment if it lasts more than 12 months. The use of an installation or drilling rig or ship in a State to explore for or exploit natural resources constitutes a permanent establishment if, but only if, such use is for more than three months in any twelve-month period
Certain U.S. filing requirements of Canadian entities
Permanent establishment
> A permanent establishment is deemed to exist in a State where a person (other than an independent agent) has the authority to sign contracts on behalf of a resident of the other State and habitually does so
Certain U.S. filing requirements of Canadian entities
> However, a permanent establishment does not include a fixed place of business used solely for, or a person referred to in the previous paragraph engaged solely in, one or more of the following activities:
(1) the use of facilities solely to store, display, or deliver goods or merchandise of the enterprise
(2) the maintenance of inventory or merchandise belonging to the enterprise solely for storage, display, or delivery purposes;
(3) the maintenance of inventory or merchandise belonging to the enterprise solely to be processed by another enterprise;
(4) the purchase of goods or merchandise or the collection of information for the enterprise; and
(5) advertising, supplying information, scientific research or similar activities that are of a preparatory or auxiliary character. An enterprise does not have a permanent establishment in a State merely because it carries on business in that State through a broker,
general commission agent, or any other agent “of an independent status,” provided that person acts in the ordinary course of its business
Certain U.S. filing requirements of Canadian entities
> Where an enterprise of Canada provides services in the U.S., if that enterprise is found not to have a permanent establishment in U.S., that enterprise will be treated as providing its services through a permanent establishment in U.S. if and only if:
(a) those services are performed in U.S. by an individual who is present in that other State for a period or periods aggregating 183 days or more in any twelve-month period, and, during that period or periods, more than 50% of the gross active business revenues of the enterprise consists of income derived from the services performed in that other State by that individual
(b) the services are provided in US an aggregate of 183 days or more in any twelve-month period regarding the same or connected project for customers who are either residents of US or who maintain a permanent establishment in U.S. and the services are provided regarding that permanent establishment
Certain U.S. filing requirements of Canadian entities
> Thus, if there is no permanent establishment based on the application of the U.S.-Canada income tax treaty, then a protective Form 1120-F should be filed to assert Treaty protection
2009 $3.5 million Step up in basis $3.5 million 45% $1 million 45%
2010- 0 - Modified
carryover basis - 0 - 0%$1 million 35%
$5 million Step up in basis $5 million 35%
20111 $5 millionStep up in
basis
$5 million35%
$5 million35%
20122 $5.12 million(portable) $5.12 million $5.12 million
(portable)
2013 $1 million Step up in basis $1.36 million 55% $1 million 55%
2013 ATRA
$5.25 million(portable)
Step up in basis $5.25 million 40% $5.25 million 40%
1 Beginning in 2011, there was the introduction of the portability of the estate tax exemption between married couples (Note: not applicable to GST tax or state estate tax exemptions). Under ATRA, portability provision extended. 2 Estate, GST, and gift tax exemptions were indexed for inflation in 2013.
Annual exclusion for 2015 indexed for inflation to $14,000 (up from $13,000 in 2012)
> U.S. citizen decedent’s estate, who is not a resident of Canada, owns Canadian real property- Likely to incur Canadian capital gains tax- Foreign death tax credit allowed in U.S. for amount paid
to Canada
> Canadian decedent owned U.S.-situs real property- May be able to offset Canadian income tax with credit of
amount equal to U.S. estate tax related to U.S. asset
> Important to comply with Canadian income tax foreign reporting obligations - T1134 Form – due 15 months after year-end- T106 Form – due 6 months after year-end
• Exercise care when reviewing form – each false statement or omission subject to a $24,000 penalty
> Transfer Pricing considerations- Specific documentation and evidence (“Contemporaneous
Documentation”) required to support non-arm’s length transactions with non-residents to mitigate the risk of penalties
- Penalty is computed as 10% of the total of the transfer pricing adjustments if this total exceeds the lesser of 10% of gross revenue or $5M
- Penalty applies to the full amount of the pricing adjustments (not just the tax on the pricing adjustments) if the appropriate documentation is not in place
> If U.S. operations are considered “active” business for tax purposes, significant deferral opportunity may be available to the extent individual shareholders do not extract any after-tax profits
> Intercompany transactions – “Low hanging fruit for the IRS”- Management fees- Reimbursement of costs – need to be very careful which costs are being
reimbursed
> Structure considerations- Need to exercise caution when introducing Limited Liability Companies
(“LLCs”) in your outbound structure- Commencing in 2009, outbound LLCs may be subject to 30% U.S.
Branch Tax• Results in an overall U.S. tax rate of up to 54.50% (plus state tax)!
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