Dividends Recieved From Foreign Corporations‚ Recent Developments Change the Landscape

The American Jobs Creation Act of 2004 is a big deal because it has new rules for how foreign income is taxed in the U.S. One part, called §965, lets U.S. companies pay a lower tax rate on money they bring back from their foreign subsidiaries. But individual shareholders can’t get this benefit. Another part of the law, from 2003, says that individuals who get certain types of dividends from foreign companies can pay a lower tax rate on that income. Overall, these new rules are supposed to make it easier for companies and people to bring money back from overseas and pay less in taxes. If you get dividends from a company in the U.S. or from a foreign company in a country that has a good tax treaty with the U.S., you might be able to pay a lower tax rate on those dividends. Some countries, like the Cayman Islands and the Bahamas, don’t have good enough tax treaties with the U.S., so dividends from companies in those countries won’t qualify for the lower tax rate. Also, if a foreign company is considered a passive foreign investment company, you won’t get the lower tax rate on dividends from that company. But, other types of foreign companies in good tax treaty countries will qualify for the lower tax rate on dividends. A foreign corporation can be classified as a PFIC if most of its income comes from passive sources or if over half of its assets produce passive income. However, a CFC, which is owned by U.S. shareholders, can still pay qualified dividends. If a foreign corporation is both a CFC and a PFIC, it will be treated as a CFC for U.S. shareholders who own at least 10 percent of the corporation’s voting stock. This means they can still receive dividends at a lower tax rate. The 2004 Act changed the rules so that a CFC that is also a PFIC can now pay qualifying dividends if most of its income is not passive. Foreign corporations that were FPHCs in 2003 or 2004 couldn’t distribute their earnings and profits as qualifying dividends if they were accumulated in years when they were not FPHCs. But this changed after 2004, so they can now distribute those earnings and profits as qualifying dividends.
Using a holding company in a low or zero-tax jurisdiction can help a foreign corporation convert offshore income into qualifying dividend income for U.S. shareholders. There are certain countries, like Denmark, Australia, and Switzerland, with favorable holding company regimes that make this strategy tax-efficient. In Denmark, if a company owns at least 20 percent of another company’s shares for at least one year, they won’t have to pay taxes on the dividends they receive from that company. The same goes for a U.S. shareholder who owns at least 20 percent of a Danish holding company for at least one year. In Australia, a holding company can receive tax-free dividends if they own at least 10 percent of the lower-tier subsidiary’s voting shares, and they don’t have to pay taxes when sending dividends to the U.S. as long as the Australian company is 100 percent equity-funded. Austria and Switzerland both have favorable tax rules for companies that own shares in foreign companies. In Austria, if a company owns at least 10% of a foreign subsidiary’s shares for a year, it can bring home the subsidiary’s profits without paying Austrian taxes. In Switzerland, a company that owns at least 20% of a foreign subsidiary’s shares, or shares worth at least CHf62 million, can do the same. However, the Swiss company will have to pay a 35% tax when sending the profits back to the US, though US taxpayers can get some of that tax refunded. Cyprus has a good tax system for companies. If a Cyprus company owns at least one percent of a foreign company, it doesn’t have to pay taxes on the dividends it receives from that foreign company. The foreign company needs to pay at least five percent in taxes, unless more than half of its income comes from passive sources. In that case, the Cyprus company would still not have to pay taxes on the dividends. Also, Cyprus doesn’t tax dividends paid to shareholders outside of Cyprus. However, in the US, income from foreign companies cannot qualify for the lower 15% tax rate. There are new rules that make it easier for foreign companies to bring their money back to the U.S. without paying a lot of taxes. However, the IRS might still try to challenge this by saying that the foreign holding company is just a middleman for the money coming to the U.S. The companies can argue against this by making a special tax election. The treaties between the U.S. and the holding company jurisdictions would all seem to meet the requirements for the foreign corporation to be considered a “qualified foreign corporation.” For example, the treaties with Australia, Austria, and Denmark require the foreign holding company to be at least 50 percent owned by U.S. residents and not have more than 50 percent of its income paid to non-U.S. residents. The U.S.-Switzerland treaty has similar requirements, with the added condition that 95 percent of the Swiss holding company’s shares are owned by seven or fewer residents of a member state that is a party to NAFTA (including U.S. residents), and that less than 50 percent of its expenses are paid to non-U.S. citizens. Given that the proposed structures involve a foreign holding company that is 100 percent owned by U.S. residents and all or most of the company’s income is paid to U.S. residents as non-deductible dividends, these requirements should be met. In simple terms, if a company in Cyprus is 100% owned by people from the US, it’s not clear if it can get tax benefits under the US-Cyprus income tax treaty. The treaty says a Cyprus holding company can get benefits if at least 75% of its shares are owned by people from Cyprus, and its income is not used to pay off debts of people from other countries. However, there’s an exception if the main reason for setting up the company was not to get treaty benefits. In the cases we talked about, the rules of the treaty would not be met because the company would not be more than 75% owned by people from Cyprus. There’s a debate about whether the company is trying to get treaty benefits or not, but until we get more guidance, it’s better to pick a different country than Cyprus for tax purposes, like Australia, because they have similar requirements for tax benefits. In 2004, the U.S. government made it easier for people to bring back money they earned from investments in other countries and only pay a 15% tax on it. This means that individuals can reorganize their overseas investments to bring back money that wasn’t taxed before as qualifying dividends. This document explains the American Jobs Creation Act of 2004, which includes tax provisions for U.S. shareholders of foreign corporations. It discusses the taxation of dividends received from foreign corporations, and the rules for determining if a foreign corporation is a controlled foreign corporation, a passive foreign investment company, or a foreign personal holding company. It also explains the tax benefits and requirements for U.S. residents with foreign corporations in countries with tax treaties with the U.S. This Act is important for U.S. shareholders of foreign corporations and has tax implications for them. Two lawyers, William B. Sherman and Jeffrey L. Rubinger, work at a law firm in Ft. Lauderdale. They both studied law and taxation at prestigious universities and are licensed to practice law in Florida and New York. They are also involved in a Tax Section committee with other lawyers.

Source: https://www.floridabar.org/the-florida-bar-journal/dividends-recieved-from-foreign-corporationsrecent-developments-change-the-landscape/