Basic Principles of deciding a tax jurisdiction for international transactions

For international transactions Governments have to decide which person and what income needs to be taxed. The basis for this can be personal relationship and economic relationship.

Personal relationship is based on citizenship or resident status and economic status is based on income derived from property or activities with in a country’s border.

If a taxpayer is resident of one country and derives income from another country, it can lead to a problem of double taxation. Host country can assert taxes based on taxpayer’s economic relation and home country can assert taxes based on personal relationship of the tax payer.

Home country will usually resolve double taxation issues of its citizens and residents by either:

1. Allowing them and exclusion of foreign earned income.
2. Or by allowing foreign tax credit for any taxes paid in the foreign country on that income.

The United States follows this foreign tax credit system and tax United States persons on their worldwide income under code section 61.

Code section 61 covers income from all sources (but not limited to) as mentioned below:

1. Compensation for services, including fees, commissions, fringe benefits and similar items.
2. Gross income derived from business.
3. Gains from dealing in property.
4. Interest.
5. Rents.
6. Royalties.
7. Dividends.
8. Alimony and separate maintenance payments.
9. Annuities.
10. Income from life insurance.
11. Pensions.
12. Income from discharge of indebtedness.
13. Distributive share of partnership gross income.
14. Income in respect of a decedent.
15. Income from an interest in an Estate or Trust.

The United States taxes all U.S persons on their worldwide income. Under the law U.S persons are U.S Citizens, Green holders and Corporations organized under U.S law.

U.S persons who have foreign source income can claim credit for the foreign taxes paid under code section 903. There is a foreign tax credit limitation that restricts the credit attributable to foreign source income.

Deferral Privilege:

If a U.S person earns a foreign income through a foreign corporation, he can defer the taxes till that foreign income is repatriated to U.S through dividend distribution.

Under code section 911, U.S citizens or resident aliens who live and work abroad for extended periods of time can exclude a limited amount of foreign earned income and housing cost amount from their U.S tax. For 2013, foreign earned income exclusion is $97,600.

Under code section 871(b) and 882, If foreign persons have income that is connected with a trade or business with the United States, they will be taxed at graduated rates.

Under code section 871(b) and 881, if a foreign person has U.S source investment income, it is subject to a withholding tax at flat rate of 30%. Withholding tax on interest, dividend and royalty income can be reduced to 15% or less due to income tax treaties.

Capital gains from stocks, bonds and other securities are usually exempt from U.S taxes.

According to code section 897, gains from the sale of real estate property are taxed in the same way as income effectively connected with trade or business activities in the U.S.