Expanding internationally is always an exciting adventure.  Before jumping in head-first it is important to understand all the ramifications, including tax compliance, when entering the United States markets.

Form 1120-F is crucial for foreign corporations operating in the U.S. The 1120-F is a federal level return that reports the income tax pursuant to the federal (Internal Revenue Service) rules.   It is important to be proactive in planning for and staying ahead of this U.S. tax filing.

What triggers a form 1120-F filing requirement?

Form 1120-F is required to be filed when a foreign corporation:

  1. was engaged in a U.S. trade or business;
  2. had income, gains, or losses treated as if they were effectively connected with the conduct of a U.S. trade or business;
  3. received U.S. source fixed, determinable, annual, periodic (“FDAP”) income and withholding under IRC 1442 was not satisfied;
  4. wants to claim a refund or any deductions, credits, or treaty benefits; or
  5. wants to file a protective return.

Engaged in a U.S. trade of business and 2. Effectively connected Income (ECI)

The U.S. federal government has minimum thresholds that a foreign corporation must reach before having to file a federal 1120-F. One such threshold is to be “engaged in a U.S. trade or business.”   While having a business office or factory in the U.S. is more obvious, a U.S. agent that regularly concludes contracts on behalf of the foreign company may also trigger a filing requirement.

The IRS does not offer a clear definition of “engaged in a U.S. trade of business.”  IRC 864(b) has special rules for the performance of services and trading in securities.  Otherwise, judicial and administrative guidance looks to facts and circumstances to support sufficient economic activity that is determined to be considerable, continuous, and regular.

ECI is any income that is connected or attributable to a U.S. trade or business. Some guidance for this determination is provided in IRC 864(c).

For countries where the U.S. has an income tax treaty, there is a bit more clarity.  The typical U.S. treaty provides guidance as to the activities that rise to the level of being “engaged in a U.S. trade or business.” The treaty defines this as a Permanent Establishment (PE).  Generally, if a company has a PE under a treaty, then it will also be engaged in a U.S. trade of business and need to prepare the 1120-F.

IRC 1442 withholding on FDAP income

IRC 1442 requires a default 30% (or lower treaty rate) tax withholding on payments to foreign persons of U.S. source FDAP income. FDAP generally includes interest, dividends, royalties, pensions, and annuities.  If the incorrect amount of tax was withheld, the foreign corporation will file an 1120-F to get a refund or pay additional tax.

1120-F protective returns to claim tax benefits

A foreign corporation can only claim deductions, credits, or benefits for purposes of determining its U.S.  tax liability if a “timely“ return is filed per IRC 882(c). This generally means that if a foreign company does not file an 1120-F and later it is determined that it has U.S. ECI, it will pay tax on gross income with no deductions or treaty benefits allowed.

If a foreign company with U.S. activity believes it does not have a tax filing requirement under a treaty, a protective 1120-F should still be filed for the following reasons:

  • The treaty benefit is claimed on the form 8833 attached to the form 1120-F. The 8833 will clearly cite the treaty article that applies to remove the filing requirement.
  • If, for any reason, a determination is made that facts and circumstances do not support the treaty position, filing the 1120-F preserves the right to claim deductions and credits in a later filed return.

If a foreign company is entering the U.S. from a non-treaty country, and there is uncertainty as to whether it is engaged in a U.S. trade or business, it may be best to file an 1120-F.  This will protect the right to receive the benefit of deductions and credits on an amended return as the issues are sorted through.

What about U.S. state and sale tax filing requirements?

The 1120-F instructions and U.S. treaty definitions are not to be confused with a different set of rules for each U.S. state’s income tax.  To further complicate compliance, each U.S. jurisdiction has different thresholds for sales tax filings.

How can we help?

There is no reason to shy away from U.S. markets due to tax compliance.  You just need the right guidance to navigate the system and understand your risks and exposures. The International Tax Team at PBMares, LLP can assist you in all aspects of the U.S. tax planning and compliance as your business continues to grow in the United States.