The United States usually taxes foreign companies at a flat rate of 30 percent on any interest they receive from American sources. However, there’s a special rule called the portfolio interest exemption that can lower or eliminate this tax. This exemption doesn’t apply if the interest is connected to a U.S. business. This means that if a foreign bank loans money to a U.S. company, the interest on that loan won’t qualify for the exemption. An example of this is a Florida company borrowing money from a foreign corporation. The loan isn’t guaranteed, and the interest rate is fixed. The foreign corporation isn’t related to the Florida company and isn’t a foreign bank. The Portfolio Interest Exemption is a rule that allows foreign taxpayers to receive interest from U.S. sources without being taxed at a high rate. The exemption applies to interest paid on certain types of promissory notes or obligations, as long as they are owned by foreign persons and meet certain requirements. However, there are some exceptions to this exemption, such as if the interest is received by a 10 percent owner of the company or if it is paid within certain countries with inadequate information sharing with the U.S. Foreign banks may receive interest on loans to U.S. borrowers, but if the loans are made in the normal course of the bank’s business, the interest will be subject to U.S. tax. Using “back-to-back loans” to try to avoid this tax is no longer allowed. If a U.S. borrower knows or has reason to know that a loan is part of a back-to-back arrangement, they could be responsible for not withholding U.S. tax on the interest payments to the lender. Before 1984, the rules for exempting portfolio interest only applied to interest received on obligations issued after July 18, 1984. There are extra rules for when foreign corporations owned or controlled by U.S. persons receive portfolio interest, but we won’t get into that here. Also, U.S.-source interest paid to a resident of a foreign country may not be exempt from U.S. tax if that country doesn’t share information with the U.S. But don’t worry, Country X is not one of those countries. It’s important to know the type of entity and the owners of each lender to determine if the portfolio interest exemption applies. Contingent interest, which is interest that depends on how well a company is doing, doesn’t qualify for a tax exemption. Also, if a company pays interest to a related person or a person who doesn’t pay much U.S. tax on the interest income, they might not be able to deduct that interest from their taxes. So, it’s important to make sure that no one involved is related and that no one will guarantee the interest payment. Treaties between the U.S. and other countries can lower the amount of tax that needs to be paid on interest earned by someone from that other country. The specific rules and paperwork for getting the lower tax rate can vary, so it’s important to know exactly what kind of entities the people involved are and where they are from. If they are from a country with a treaty, they may be able to pay less tax on the interest they earn. In simple terms, the rules for borrowing money from foreign lenders can be really complicated. There are a lot of exceptions and special rules to think about. This article shows how a company can borrow money from a foreign lender without having to withhold taxes on the interest payments. But it’s important to remember that if certain things about the loan change, the whole situation could also change. Some important things to consider are that the loan can’t be guaranteed, the interest rate on the loan has to be fixed, and the foreign lender can’t be related to the company in any way. The Internal Revenue Code requires nonresident aliens and foreign corporations to have taxes withheld on certain types of income they earn in the US. There are specific rules and exceptions that apply, and these rules may change depending on the situation. It’s important to follow the regulations to avoid any issues with the IRS. Brian K. Jordan is a lawyer who specializes in business and tax law in Orlando. He is licensed to practice law in Florida, Alabama, Tennessee, and the United States Tax Court, and he is also a certified public accountant. He is a member of The Florida Barâs Business Law and Tax sections and the ABAâs International and Tax Law sections. This column is from the Business Law Section.
Source: https://www.floridabar.org/the-florida-bar-journal/business-and-tax-planning-with-the-portfolio-interest-exemption/
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