Tuesday, August 31, 2010

Panama heading for target of 12 Double Taxation Agreements

Panama will negotiate with Singapore next week the 12th double taxation agreement (DTA) required to exit the gray list of the Organization for Economic Cooperation and Development (OECD).

On Aug 18 negotiations were completed for a double taxation avoidance agreement with South Korea.

A double taxation agreement with Mexico has been ratified by the Panama legislature. Other treaties have been signed with Barbados, and negotiations have been closed with France, Italy, Belgium, Spain, Netherlands, Qatar, Luxembourg and Portugal.

http://www.asamblea.gob.pa/actualidad/proyectos/2010/2010_P_156.pdf Mexico-Panama Agreement for Double Taxation Avoidance and Tax Evasion Prevention

In the last 6 months, bills have been entered into the Panama legislature to ratify Bilateral Investment Treaties for the protection of investments with Italy, Belgium, Qatar, and Luxembourg granting national treatment to investments from those countries.
http://www.asamblea.gob.pa/actualidad/proyectos/2010/2010_P_153.pdf Qatar
http://www.asamblea.gob.pa/actualidad/proyectos/2010/2010_P_146.pdf Italy
http://www.asamblea.gob.pa/actualidad/proyectos/2010/2010_P_148.pdf Belgium-Luxembourg
http://www.asamblea.gob.pa/actualidad/proyectos/2010/2010_P_147.pdf Finland

A bill to ratify a Mutual Legal Assistance Treaty with Russia has been submitted. This Agreement provides that:
Bank secrecy can not be used as a basis for denying legal assistance.
3. The Parties may not refuse a request for legal assistance only because it is considered that the crime also involves tax matters.
http://www.asamblea.gob.pa/actualidad/proyectos/2010/2010_P_150.pdf Russia MLAT Bill

Wednesday, August 25, 2010

Panama Property Tax Lawyer

You do not need a lawyer to do your property tax. If you are computer proficient and can follow some Spanish with Google translate, you can go to www.dgi.gob.pa and:

- get a NIT password to see your annual property tax statement online and print tax certificates online,

- download the eTax 2010 software from which can help you estimate payable capital gains and property transfer taxes in case of a sale.

Alternatively, CPAs are better at estimating taxes than lawyers, who can be of help if a claim against the Ministry is involved. Property tax rules change a bit every year. Some rules are posted at:

--- On Tue, 7/6/10, maukapete <maukapete@yahoo. com> wrote:

From: maukapete <maukapete@yahoo. com>
Subject: Americans In Panama - Panama Property Tax Lawyer
Date: Tuesday, July 6, 2010, 11:01 AM

Does anyone know a Panamanian lawyer named N who does property taxes for homes? If no one knows Lic. N, does anyone know a Panamanian lawyer who does property taxes without jerking me around? Pete Peterson

Monday, August 23, 2010

Panama-France Treaty protects Panama corporations

A little-known treaty, called the Franco-Panamanian Treaty of Establishment from 1953, provides that investments in each of the signatory countries by investors of the other state, are subject to equal treatment. A Panama corporation with one Panamanian as shareholder was therefore exempt from a punitive anti-tax haven 3% tax levied on French properties owned by non-residents.

Friendship treaties can also serve as tax avoidance tools when double taxation treaties are absent.

France: Non-Discrimination and the Treaty of Establishment with Panama

by Stefan N. Frommel, London

  1. Conseil d'Etat: Resources Management Corporation S.A., 16 December, 1991

A. The facts

Resources Management Corporation was a company limited by shares incorporated in Panama. The company had issued 5,000 shares in bearer form and only two of the shareholders were known to the French tax authorities: a Mr. Arias and a Mr. Suarez, each holding one share. The remaining 4,998 shares were in the hands of shareholders who had not been identified.

Resources Management owned a villa in Eze-sur-Mer, on the Còte d'Azur; it had no other property or other activities in France. The villa was – the whole year round an free of charge – atthe disposal of Mr. Chofaras, a Greek national, who lived in Paris, at avenue de l'Are de Triomphe.

Resources Management had never filed a tax return. The tax authorities assessed the company to corporation tax for the years 1974 to 1977. For 1974 to 1976 the tax was assessed on the basis of the real rental value of the property. For 1977 it was assessed on three times the real rental value, according to article 209A, which came into force on 1 January, 1977.

Only the assessment for 1977 is relevant for our purposes.

B. The Conclusions of the Commissaire du Gouvernement

In his conclusions, M. Fouquet made the observations summarized below and requested the court to discharge the assessment for 1977.

(a) The administration argued that tax treaties traditionally allocate the right to tax income from immovable property to the Contracting State in which such property is situated. M. Fouquet observed:

  • The court had previously decided (in Le Beau Logis and Quadriga) that the non-discrimination clauses in the tax ([...])

  • As a result of these decisions the Government has asked Parliament to abolish Article 209A and replace it with the 3 percent annual tax on the market value of French real property (article 990D of the General Tax Code).

  • Article 7 of the treaty with Panama, being similar (analogue) to the non-discrimination clauses found in the vast majority of tax treaties, should be given the same effect.

  • It was not contested that “nationals”, the term used in the treaty, applied not only to individuals but also to legal persons, according to Royal, which he cited.

(b) The administration argued that article 7 of the treaty with Panama did not refer to “corporation tax”. M. Fouquet observed:

  • The wording of article 7 (“duties, levies, taxes, or contributions, of whatever denomination”) was sufficiently wide to include corporation tax.

  • Moreover, it was no longer relevant, since Nicolo, that the law of 29 December 1976 (at the origin of article 209A) was subsequent to the treaty.

(c ) The administration argued that the treaty with Panama was not valid because it had not been ratified by the president of the Republic, M. Fouquet replied:

  • According to the decision in Navigator (1965), the treaty had been properly introduced into French law by a decree of the President followed by publication in the Official Journal.

(d) To conclude, M. Fouquet mentioned Société Panagest, where the court,following his own submissions, had applied article 209A to two Panamanian companies: “Lack of sufficient time”, he said, had prevented him from discovering earlier the existence of the treaty with Panama.

  • Following Carboline-Europe (1986), he added, “the equality-of-treatment clause in a treaty is of [concern to] public policy (ordre public) and must be applied by the court ex officio, [even if it has not been pleaded by the taxpayer].”

C. The Decision

The relevant part of the decision reads as follows:

As far as the year 1977 is concerned:

Whereas, according to article 209A of the General Tax Code, in force at the time: 'If a legal person (personne morale) whose seat (siège) is situated outside France, has at its disposal one or more real properties or grants the use of such property either gratuitously or for a rent inferior to the real rental value, it is subject to the corporation tax on a basis which cannot be lower than three times the real rental value of the said property'; that for 1977 the petitioner has been subject to corporation tax, according to that provision, on a base equal to three times the rental value of the aforementioned villa; that, however, petitioner invokes the provisions of article 7 of the treaty of establishment between France and Panama of 10 July, 1953, published by virtue of decree 58-438 of 12 April, 1958 in the Official Journal of 23 April, 1958, according to ([...]) within the territory of the other Party, to any other or higher duties, levies, taxes, or contributions, of whatever denomination than those which are imposed on the nationals'; that these provisions form an obstacle to the fixed rate taxation (taxation forfaitaire) foreseen by article 209A of the General Tax Code; that the company limited by shares Resources Management Corporation is, accordingly, entitled to demand the discharge of the assessment to corporation tax to which it was subjected for the year 1977.

[The court] decides: …

The company limited by shares Resources Management Corporation is discharged from the assessment to corporation tax and ancillary penalties to which it was subjected for the year 1977.”

VI. A Point That Was Not Raised: Abuse of Rights

A word of caution for anyone planning to use Panamanian companies to hold French real estate: beware of the doctrine of abus de droit. It was not raised in Resources Management, but might well be invoked in other cases.

In French tax law, the expression abus de droit (abuse of rights) refers to unacceptable tax avoidance. Outside the tax field it has a different meaning and refers to a doctrine that has been developed by the French courts and become a “general principle of law”: a person acts unlawfully, or he made use of a right with the intention or purpose of causing harm to another person. Transposed to taxation matters, the doctrine means this: although a taxpayer has a right to arrange his affairs in any way which is legal, he abuses that right if he exercises it solely to avoid tax.

VII. Are Panamanian Companies Protected from the 3 Percent Annual Tax on the Market Value of French Real Property?

A short note, signed with the initials “O.F.” (Olivier Fouquet?) is appended to the report of Resources Management in the Revue des Sociétés. ([...]) … times the rental value of French real property) appeared to be “transposable” to the “new” 3 percent annual tax on the market value of the property (imposed by article 990D which replaced article 209A) because the Cour de Cassation had also decided (in Société Royal) that a non-discrimination clause in a “bilateral treaty” was an obstacle to application of this tax.

This analysis is correct and is shared by another commentator, M. Phillipe Derouin.

Comparing Société Royal with Resources Management it is apparent that both decision have three fundamental points in common:

  • A tax that is discriminatory because it applies only to companies which have their seat outside France (both taxes are closely related: one replaced the other).

  • A treaty with a non-discrimination clause (both clauses have similar wording).

  • A constitutional principle of supremacy of treaties over domestic legislation (both taxes were enacted after conclusion of the treaties).

In this circumstances, unless the Constitution is amended or the treaty is renegotiated, it is doubtful that the 3 percent tax imposed by article 990D of the General Tax Code could ever apply to Panamanian companies.

Full text in Tax Planning International Review (1992) . Extract posted with thanks to Alexandra Stoffl (University of Vienna, B.Sc., LLM)

Wednesday, August 11, 2010

US citizens face penalties when failing to report their offshore accounts

Kevin Mullin: Ramifications of U.S. Crackdown on Foreign Tax Havens
By Kevin Mullin, JD, CPA, LLM (Tax)

Compelled by the current recession to raise revenues from all quarters and emboldened by reports of thousands of U.S. taxpayers with unreported foreign accounts, the current administration is moving to crack down on rogue U.S. taxpayers with investments stashed abroad.

While the UBS scandal has attracted the most publicity, leading to the discovery of thousands of unreported accounts held by Americans, Switzerland is not the only focus. The Internal Revenue Service recently announced the opening of its first criminal investigation office in Panama and the agency is targeting far-flung jurisdictions which permit bank-secrecy, as well as tax havens around the world.

This has a direct impact on the thousands of U.S. taxpayers investing in real estate outside of the U.S., who often use a foreign bank, financial account, corporation, partnership or trust to take title to the property. They provide a convenient cash management account from which to make such investments or meet expenses of ownership. But they don't necessarily shield owners from IRS scrutiny, as the U.S. account-holders of UBS have found out.

Most U.S. taxpayers with international investments are likely aware that they are required to declare income earned from all sources located anywhere in the world, but many are not aware of the extensive reporting requirements on foreign accounts and investments, regardless of whether they generate any taxable income. Nor are many investors aware of the draconian penalties that attend their non-compliance.

Besides the obvious obligation to report income, there are extensive requirements for the owners (or constructive owners) of such accounts to report transfers and ownership of foreign corporations and trusts, as well as ownership or signature authority over foreign financial accounts.

While many of these reporting requirements have been on the books for years, the focus of the U.S. on enforcing them has been, until recently, pretty half-hearted. But now the IRS is pursuing this arena with vigor.

The administration's efforts culminated earlier this year with amnesty program for U.S, taxpayers with unreported income from foreign accounts--an admission that providing amnesty might bring new sources of revenue, which would otherwise simply burrow deeper underground. The amnesty program allowed qualified U.S. taxpayers with unreported income from foreign accounts to generally be relieved of criminal sanctions, although they would still be subject to back taxes, interest and civil penalties.

The announcement of the amnesty program, which ended on Oct. 15, triggered an avalanche of disclosures that have overwhelmed IRS staff. In its wake, a plethora of proposed legislation has been introduced aimed squarely at bringing a spotlight to the offshore arena.

Hereafter, the gloves are off and U.S. taxpayers who are discovered to have unreported income from foreign accounts should not expect a conciliatory attitude on the part of the IRS. For those U.S. taxpayers with foreign-source income and financial accounts, the requirement for obtaining competent legal counsel and accounting advice could not be more critical to their overall tax compliance efforts.

The following is a summary of the reporting requirements and potential civil penalties that could apply to a taxpayer, depending on their particular facts and circumstances. Note that serious criminal penalties with financial, as well, as incarceration possibilities are also possible for willful infractions. And if the IRS discovers non-compliance prior to the taxpayer providing information on a voluntary basis, the opportunity of pleading ignorance or inadvertence will likely fall on deaf ears and the likelihood of a criminal investigation increases.

A short summary of some of the compliance requirements:

  • A penalty for failing to file the Form TD F 90-22.1 (Report of Foreign Bank and Financial Accounts, commonly known as an �FBAR�). U.S. citizens, residents and certain other persons must annually report their direct or indirect financial interest in, or signature authority (or other authority that is comparable to signature authority) over a financial account that is maintained with a financial institution located in a foreign country if, for any calendar year, the aggregate value of all foreign accounts exceeded $10,000 at any time during the year. Generally, the civil penalty for willfully failing to file an FBAR can be as high as the greater of $100,000 or 50 percent of the total balance of the foreign account. Non-willful violations are subject to a civil penalty of not more than $10,000 for each account and for each year that the account is unreported.
  • A penalty for failing to file Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts. Taxpayers must also report various transactions involving foreign trusts, including creation of a foreign trust by a U.S. person, transfers of property from a U.S. person to a foreign trust and receipt of distributions from foreign trusts. This return also reports the receipt by U.S. persons of gifts from foreign entities. The penalty for failing to file each one of these information returns, or for filing an incomplete return, is 35 percent of the gross reportable amount, except for returns reporting gifts, where the penalty is five percent of the gift per month, up to a maximum penalty of 25 percent of the gift.
  • A penalty for failing to file Form 3520-A, Information Return of Foreign Trust With a U.S. Owner. Taxpayers must also report ownership interests in foreign trusts, by U.S. persons with various interests in and powers over those trusts under section 6048(b).The penalty for failing to file each one of these information returns or for filing an incomplete return, is five percent of the gross value of trust assets determined to be owned by the U.S. person.
  • A penalty for failing to file Form 5471, Information Return of U.S. Person with Respect to Certain Foreign Corporations. Certain U.S. persons who are officers, directors or shareholders in certain foreign corporations (including International Business Corporations) are required to report information. The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.
  • A penalty for failing to file Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation. Taxpayers are required to report transfers of property to foreign corporations and other information. The penalty for failing to file each one of these information returns is ten percent of the value of the property transferred, up to a maximum of $100,000 per return, with no limit if the failure to report the transfer was intentional.
  • A penalty for failing to file Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships. U.S. persons with certain interests in foreign partnerships use this form to report interests in and transactions of the foreign partnerships, transfers of property to the foreign partnerships, and acquisitions, dispositions and changes in foreign partnership interests. Penalties include $10,000 for failure to file each return, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return, and 10 percent of the value of any transferred property that is not reported, subject to a $100,000 limit.

Kevin Mullin is a tax attorney with more than 20 years experience in international tax and estate planning services. With offices in Denver, Co., and McLean, Va., he can be reached at http://www.intl-taxlaw.com/. He also maintains representative offices in Latin America and the Middle East to support his professional and client relationships globally.

Monday, August 09, 2010

EB-5 visa still attractive for the millionaires moving to the US

For affluent immigrants unwilling to deal with long waiting lists, the EB-5 Visa program provides a fast track for immigrating to the U.S. The basic requirements are to set up a business for a minimum of $1 million (or $500,000 in “Regional Centers” in rural areas or urban regions with high unemployment rates) which provides 10 jobs by investing here.
For citizens in countries with political unrest such as Venezuela and Mexico and higher tax rates such as U.K., the EB-5 is a useful alternative. Advantages include:
  • 10,000 green cards reserved each year for the EB-5 regional center program
  • No minimum education requirement
  • No business or management experience requirement
  • No language requirement
  • No excessive waiting periods or quota backlogs
  • No sponsor needed
  • Investment capital can come from any lawful source
  • Investors not required to manage their investment on a daily basis so they may pursue other professional and personal ventures inside or outside of US
  • Satisfy job creation requirements by counting both direct and indirect jobs

June 11, 2010, 8:24 AM ET
Immigrant Investors, An Underserved Market

Finding new clients is a challenge for all financial advisers. But most advisers are overlooking an untapped and growing client base: wealthy foreign investors seeking to gain permanent residency in the U.S.
EB-5 green cards also allow affluent foreign investors (and their family members) to work in the U.S. in any capacity, go to school, or retire here.
Each year, 10,000 visas are available for EB-5 investors looking to come to America.
According to the U.S. State Department, the number of so-called “investor green cards” issued nearly tripled to 4,218 in the fiscal year 2009 ended September 30, compared to just 1,443 EB-5 visas issued in fiscal year 2008.


With proper advance planning, EB-5 Program applicants can undertake measures to minimize their U.S. FIT and FTT exposure. Thus, applicants for the EB-5 Program should consider tax planning prior to becoming U.S. residents, that is, while they are still non-residents. This tax planning can be formulated so as to take effect only when the applicant knows that he or she is eligible for the EB-5 Green Card, but the urgency for the applicant to undertake this FIT and FTT planning becomes more critical as the EB-5 application proceeds towards permanent residency, as depicted below:

The "EB-5" Investor Visa Program provides foreign nationals an innovative and flexible path to permanent residency in the U.S. (Green Card) for themselves, their spouses and their children less than 21 years of age.
The EB-5 Program permits an applicant to invest a minimum of $500,000 in a U.S. Government designated Regional Center in the U.S. The Regional Centers are designed to allow pooled investments to create jobs in targeted high-unemployment areas in the U.S. Thus, the qualified applicant can obtain a Green Card without having to create their own business in the U.S. or to even emigrate to the U.S. until the Green Card has been issued. A Green Card gives the holder the right to live and work anywhere in the US.

EB-5 Visa Program Process
◆ Step 1 - The qualified applicant files form I-526, a petition requesting the U.S. Citizenship and Immigration Services to certify the applicant and the investment as eligible for the EB-5 Program.
◆ Step 2 - Upon approval of the I-526 petition, the applicant files an immigrant visa application and is interviewed at the Embassy in the applicant's home country. Upon approval of the application, the applicant is issued an immigrant visa to the United States. A conditional Green Card is issued to the applicant shortly after his/her arrival in the United States.
◆ Step 3 - After two years, the applicant must file to remove the "condition" from the Green Card using form I-829. At this time, the Regional Center will provide proof of job creation.

Tax & Estate Planning for EB-5 Program Applicants
Citizens and permanent residents of the U.S. are subject to federal income tax (FIT) on their worldwide income and to gift and estate tax (FTT) on their assets located anywhere in the world, while nonresidents of the U.S. are taxed only on their income and assets arising or located in the U.S.

MDH specializes in international income and estate tax planning for EB-5 Program applicants, and we work with nationally-recognized immigration law firms in the U.S. to assure a seamless transition for applicants becoming permanent residents of the United States. Some of our planning techniques include corporate reorganizations, foreign and U.S. trusts, partnerships, limited liability companies, life insurance, annuities, and gifting programs. We also work with our client's advisors in his or her home country to assure that the client receives complete and comprehensive tax and business planning services, and that the client and their loved ones maintain the standard of living to which they are accustomed.

Kevin J. Mullin, J.D., C.P.A., has been practicing law for over 15 years with a focus on advising foreign investors on their U.S. real estate investments and international business and tax planning. Mr. Mullin has offices in Denver, Colo., and Washington, D.C. http://www.intl-taxlaw.com/ . He also maintains representative offices in Latin America and the Middle East to support his professional and client relationships globally.

Wednesday, August 04, 2010

Swiss lawyer indicted in US after advising HSBC client

Felix Mathis, a Zurich-based lawyer at Froriep Renggli LLP, allegedly helped Dr. Andrew Silva, of Virginia, conceal from U.S. authorities foreign bank accounts at HSBC, according to an indictment filed last week at federal court in Alexandria.

A warrant has been issued for Mathis' arrest, but he is not yet in U.S. custody.

The pair used a Liechtenstein trust called Pentruvoi Trust to hide the existence of the Swiss accounts, according to the indictment.

Dr. Silva admitted his role in the transaction and received a sentence of 2 years probation. He admitted not having reported funds held at HSBC Holdings Plc. An HSBC spokeswoman declined to comment. More in http://www.businessweek.com/news/2010-06-15/surgeon-avoids-prison-for-plotting-to-hide-hsbc-cash-update1-.html

HSBC claims it does not condone or assist tax evasion http://in.reuters.com/article/idINTRE66E74S20100715However, its website advertises the benefits of offshore banking http://www.offshore.hsbc.com/1/2/international/offshore-banking and its potential tax benefits http://www.offshore.hsbc.com/1/2/international/offshore-banking/tax-benefits

Read more at the Washington Examiner: http://www.washingtonexaminer.com/local/Lawyer-accused-of-helping-hide-Swiss-bank-accounts-1001106-98639599.html#ixzz0vPN9WqJN

Copy of the indictment in USA v Felix M. Mathis, No.1:10-CR-260 in the U.S. District Court in the Eastern District of Virginia can be read at http://www.scribd.com/doc/34434671/USA-vs-Felix-Mathis

Monday, August 02, 2010

What foreign investors should know when buying property in the US

Property managers with foreign investor clients (what you should know).
By Mullin, Kevin J.
Publication: Journal of Property Management
Date: Wednesday, July 1 1998

Unless a tax treaty exists between the U.S. and a specific country, foreign owners, including estates, corporations, nonresident aliens, and partnerships, pay a flat 30 percent withholding tax on the rents produced by their U.S. real estate investments. This tax applies unless foreigners' investments are connected with a U.S. trade or business or the foreign owner has made an election with the Internal Revenue Service to be taxed on a net basis. (Having rental income taxed on a net basis after deductions for costs or operations, maintenance, and carrying charges usually results in a lower overall tax for the foreign owner.) On the other hand, U.S. citizens and residents, both individuals and corporations, are not subject to this withholding tax.

This 30-percent withholding tax is calculated on the gross amount of the rents generated by the property without allowable deductions for interest, depreciation, repairs, management and association fees, insurance, real estate taxes, or other expenses of owning and operating the property.

Managers as Agents

Since the IRS has no jurisdiction to collect this tax against a person residing in a foreign jurisdiction, the law generally designates the U.S. person who has the last contact with the money before it leaves the U.S. as a "withholding agent." The withholding agent is charged with the responsibility for paying over the 30-percent withholding directly to the IRS. Failure to do so can result in the withholding agent being personally liable for payment of the tax, plus interest and penalties.

For rental real estate, the withholding agent is typically the property management company that collects the rent from the tenants, pays the expenses of owning and operating the property, and remits the balance to the owner. Unfortunately, the property management company is often blissfully ignorant of the implications and potential for liability that the designation of withholding agent brings under law.

Avoiding the Withholding Tax: Foreign Owners

Because of this potential tax liability, the property manager needs to know with certainty whether its foreign client is subject to the withholding tax or whether the client is exempt from withholding. For the foreign investor, there are two ways to qualify for an exemption from the withholding tax and, instead, pay its fair share of income tax on a net basis after deductions.

Trade or Business. The first way a foreign person can achieve exemption from the withholding tax and be taxed on a net basis is to qualify its real estate operations as being "engaged in a U.S. trade or business." Unfortunately, there is no hard and fast rule for determining when a foreign investor's real estate operations rise to the level of a U.S. trade or business. Instead, the legal test is based on the nature and extent of the foreign investor's activities in the U.S., which leaves the foreign investor looking to various court cases for guidance.

Resolution of one's status as not being engaged in a U.S. trade or business (and thus, subject to withholding taxes) under these cases can be fairly determined if the foreign person's activities are very limited, such as owning one rental property leased on a triple-net basis. Moreover, it is fairly dear from the court cases that a foreign investor will be considered to be engaged in a U.S. trade or business if the foreign investor's activities are considerable, regular, and continuous with regard to his or her properties. For example, owning several properties and being involved directly (or through an agent) in lease negotiations, maintenance and repairs, collection of rents, payment of operating expenses, and performing record keeping, would almost certainly qualify a foreign owner for this classification. However, should a foreign investor's activities fall within these two extremes, it may be difficult to gauge the character of the investment, which leaves the foreign owner and the property manager to guess.

Net Election. Having to guess how a court will decide on the question of being engaged in a U.S. trade or business can be a hazardous way to operate real estate for both the foreign owner and the property manager. By way of relief, the Internal Revenue Code does allow a foreign corporation or nonresident alien individual to make an affirmative election to be taxed as being engaged in a U.S. trade or business, which takes the uncertainty out of the process. To qualify for the election, the foreign corporation or nonresident alien individual must derive revenue from the U.S. investment. Because the foreign person will not otherwise be able to qualify for the election, investments in nonproductive properties, such as raw land, should be leased to generate some revenue, even if the use is merely interim or temporary. In the case of a nonresident alien individual, the real estate investment must be held for the production of income.

To make the election, the foreign owner merely files a statement with his or her federal tax return that identifies that an election is being made along with a schedule of all the taxpayer's U.S. real properties, their locations, and a description of the improvements on the properties. This election is effective for all qualifying U.S. properties for all subsequent years and can only be revoked with the consent of the IRS.

The foreign investor who makes such an election also needs to file a Form 4224 annually with its property manager, which notifies the property manager
that the foreign owner is exempt from withholding tax for that tax year.

Avoiding Withholding Tax: Property Managers

That the foreign investor can elect to be taxed on a net basis is fine, but how is the property management company to know whether its principal is a foreign owner and whether the foreign client has made such an election to be taxed on a net basis, thus relieving the property manager of the withholding tax obligation? Guessing incorrectly whether one is a withholding agent or whether someone is a foreign owner or relying on a false verbal representation will not relieve a withholding agent from its obligations under the law. The best ways to avoid potential liability are:

* Assume that the property manager is a withholding agent in all cases until the IRS certification forms described below are received proving differently; and,

* Use the IRS certification forms with every client as part of the application process to systematize the approach to this issue. Completion of these forms will provide a "safe harbor" for the property manager even if it should later be determined that the owner falsified the forms and that withholding taxes should have been paid.

Property managers should become familiar with the following IRS certification forms, which need to be received from the client prior to any rental income from the property being realized. The best time to obtain such forms is at the time of management contract signing and thereafter as required.

Statement and Form 1078 (U.S. citizens and residents). U.S. citizens and residents should provide a statement in duplicate to the property manager that they are not foreign persons but citizens or residents of the U.S. No particular form is necessary for this statement, but it needs to be in writing and should be signed by the person making the statement. If the client is a person who is a resident alien of the U.S., the client can complete such a statement or can use Form 1078. No withholding is necessary from clients who complete either the statement or Form 1078, but the property manager is required to transmit the duplicate copy of the statement or Form 1078 to the IRS upon receipt.

W-8 and Form 4224 (foreign persons). Nonresident aliens and other foreign persons should complete and deliver to the property manager Form W-8, which certifies that the person is a foreign person. Completion of Form W-8 will trigger a withholding obligation on the property manager unless the foreign person also delivers a completed Form 4224. Form 4224 certifies that the income received by the property manager is exempt from withholding because it will be taxed on a net basis. Form 4224 must be filed with the withholding agent for each taxable year by the owner of the income and before payment of the income to which it applies. Failure to obtain a Form 4224 from a foreign person who claims exemption from withholding may result in denial of the exemption.

New Certification. Effective January 1, 1999, a new, simpler regime for certification will be implemented. These regulations will combine several existing forms used in connection with withholding including Form 4224 into a single, expanded Form W-8. While the new regulations should make it easier for property managers and their clients to comply, the basic system of withholding on income from real property is not being changed and must still be followed.

Other Issues for Foreigners

When acquiring U.S. real estate, there are good reasons why a foreign person should not take title to U.S. property in his or her own name, but rather should consider using an offshore-U.S. corporate structure. For example, a nonresident alien who takes title to the U.S. real estate in his or her individual name is exposed to the imposition of U.S. estate taxes, which can run as high as 55 percent on the fair market value of the property (determined as of the date of death) with very limited deductions. By comparison, U.S. estate taxes can dwarf the income tax consideration.

For foreign corporations that acquire income-producing U.S. real estate directly, a surtax, the 30-percent branch-profits tax, is imposed on top of the regular U.S. corporate income taxes. Accordingly, foreign corporations and nonresident alien individuals who currently own property in their own names should carefully consider restructuring their real estate investments into an offshore-U.S. corporate structure with the U.S. subsidiary owning the real estate directly. In this way, owners can avoid not only withholding taxes, but also U.S. estate and branch-profits taxes.

In spite of these issues, foreign persons often do take title to U.S. real estate in their own names. Thus, property managers should take precautions and seek competent professional advice so that their foreign clients' problems do not become their own.

This article is for general informational purposes only and no action should be taken or withheld based on the information supplied herein. This material is presented with the understanding that the author and the publisher do not render any legal, accounting, or other professional service. In no event will they be liable for any direct, indirect or consequential damages resulting from the use of this material.

Kevin J. Mullin, J.D., C.P.A., has been practicing law for over 15 years with a focus on advising foreign investors on their U.S. real estate investments and international business and tax planning. Mr. Mullin has offices in Denver, Colo., and Washington, D.C. www.intl-taxlaw.com . He also maintains representative offices in Latin America and the Middle East to support his professional and client relationships globally.