Tag: income

How to Create a Generation-Skipping Trust

Creating a generation-skipping trust is complicated, and the exact details of the trust will depend on the specific goals of the grantor. Two transferring strategies are available to grantors, and these are as follows:

Generation-Skipping Transfers:

Assets are placed in a trust using the GST exemption. The trust can then pay any income earned from the assets in the trust to the skip person and/or skipped generation (children/spouses), while the remaining assets in the trust pass outside of the grantor’s estate to future generations after the death of your child/spouse.

Direct Generation Skip

The grantor will bypass their own children and give the assets qualifying for the GST exemption amount directly to your grandchildren or place them in a trust for their benefit or the benefit of future generations.

Generation-Skipping Trusts & Taxes

Much like other financial trusts, a generation-skipping trust will often have taxes attached to it. Who, what, and how are listed as:

Who Has to Pay Estate Taxes?

Estate taxes are owed on any estate exceeding the federal estate tax exemption of $12.06 million. This lifetime exemption changes annually to adjust for inflation (it should be noted that should Congress not intervene, the exemption amount will revert to a $5 million baseline, adjusted for inflation, in 2026). In some states, the estate tax exemption is the same as the federal exemption; in others, this may be less than $1 million.

Gift Tax

An individual is allowed to give gifts during their lifetime without paying taxes as long as the value of the gifts does not exceed your lifetime exclusion which is the same as your estate tax exemption.

There is an annual gift exclusion of $15,000.00. However, should you grant a gift worth more than the annual exclusion, your lifetime exclusion decreases by the excess value of the gift.

Generation-Skipping Transfer Tax

The GST tax applies when someone gives direct gifts of money or other assets to someone at least 37.5 years younger than them. A flat tax rate of 40% on the transfer value exceeds the GST exemption, and GST tax can also be referred to as GSTT or simply as a transfer tax.

Benefits of Generation Skipping Trusts

The following three most common benefits are:

GST is a great planning tool for larger estates as you can ensure that your family legacy is maintained for at least two generations. It enables your own children to benefit and ensures that your grandchildren will also be supported.
GST allows the grantor to skip a round of federal estate taxes, as the federal estate taxes will only be assessed when the property is distributed to the beneficiaries of the trust. Should the assets be passed to the children of the grantor, the family legacy would have been subjected to tax twice.
GST assets are not included in your child’s estate, which effectively protects their estate. They can also retain complete control of their own trust during their lifetime.

Drawbacks of Generation-Skipping Trusts

When considering a GST, the following drawbacks need to be considered:

GST was established to ensure that families cannot escape federal estate taxes over multiple generations. If the estate’s value exceeds the GST tax exemption, it will be subject to both GST and estate taxes at a rate of 40%.
Trusts may be powerful estate planning tools that allow families to minimize their estate’s exposure to probate. However, there is a very high administrative burden of running a trust. As trusts require a lot of thought, resources, and energy, it is best to work with an estate planning professional to assist with setting up a trust that will best suit your family’s needs.
With a large enough estate, your children may still benefit from the profits generated from the assets held in trust. Suppose there is a need to support your children financially. In that case, an evaluation needs to be done to ascertain that the income produced by the GST will be substantial enough to cover their expenses and lifestyle.

Can a Generation-Skipping Trust be Broken or Dissolved?

It may be possible to dissolve a generation-skipping trust as the trust is an irrevocable trust. This means the trust cannot be broken, modified, revoked, or dissolved; however, it may be possible to modify or terminate the trust judicially, depending on the State.

Can a Generation-Skipping Trust be Contested?

A GST can be contested; however, this cannot purely be done on the basis that an individual or family member does not agree to the terms. It will need to be proven that the trust is not legally valid for the contention to be valid. Here are some valid reasons for a GST to be contested:

Mental Incapacity

The grantor needs to be ‘sound of mind’ when the trust is created, meaning the grantor needs mental awareness of what they are doing. The trust can be invalid if it is possible to prove that they were not.

Undue Influence

If a third party coerced the grantor to create the trust or name a specific beneficiary/fiduciary, the validity of the trust can be challenged. The level of pressure the grantor faces must be so severe that their own free will must be overwhelmed.

Fraud or Forgery

If a trust document was obtained through fraud, it could be contested and thrown out. This can occur when the grantor is tricked into signing the trust when they are under the impression that they are signing another document.

Asena Advisors focuses on strategic advice that sets us apart from most wealth management businesses. We protect wealth.

Who can Contest a Generation-Skipping Trust?

A trust litigation attorney can be approached to contest the GST. The aggrieved party will submit a motion or oral application to a High Court.

Do I Need A Trust Litigation Attorney To Contest A Generation Skipping Trust?

Some states, such as California, do not require a trust litigation attorney to contest the validity of a GST. However, it would be most beneficial for the person challenging the trust to employ one. Other states do require a Trust litigation attorney to be appointed by the aggrieved party or family members to submit a motion or oral application to a High Court.

Is a GST Trust Revocable or Irrevocable?

A GST is an irrevocable trust; however, the grantor can still make decisions regarding the investments made in the trust and the distributions made from the trust.

Protect against the Generation-Skipping Transfer Tax

In order to protect against the GST Tax, it is crucial to consider the most tax-efficient planning tools. As the lifetime exemption applies to an individual, it is possible to put an estate plan in place which may allow each spouse to apply for their GST tax exemption either during their lifetime or at the time of their death when the trust is created.

Common Transfer Strategies for You to Discuss with Your Tax and Legal Advisors

Bring up options for GST as an irrevocable trust to your tax or legal advisor, as they will best recommend options that are unique to your case and circumstances. The same can be done for tools to protect against the GST tax discussed above.

How to Use a Lifetime Exemption from GST

Lifetime exemption from GST can be used during the grantor’s lifetime or at the time of their death when the assets are inherited outright by the next generation or transferred into the trust. During the lifetime of the grantor, all applicable transfers of wealth made are automatically applied to the lifetime GST exemption unless elected otherwise. Also taken into consideration is that it’s also possible to employ the annual gift tax exclusion to ensure that not too much of the GST exemption is used up during the course of the grantor’s lifetime. For transfers at death, the exemption may be allocated as directed in the will of the grantor or as directed by the executors if not explicitly mentioned in their wills.

Speak with an Asena consultant to learn more about your generational skip trust case.

–Jean-Dré Tombisa

–Peter Harper

U.S. Expats in Australia Taxes

Posted on January 4, 2023October 26, 2023 by Peter Harper

U.S. Expats in Australia Taxes

Whether you’re a U.S. citizen or a green card holder living in Australia, you need to be aware of your tax obligations as a U.S. expatriate in Australia, which can be a complex issue without guidance.

As a general rule of thumb, a U.S. expat working or living in Australia should assume they have a tax obligation in both the U.S. and Australia.

How U.S. Taxes Work for American Expats in Australia

Working as a U.S. expatriate in Australia can impact your U.S. tax obligations even if your stay in Australia was short-term.

For instance, if you earn income while on a short-term assignment in Australia, you are required to report that and any other income earned in Australia on your U.S. taxes.

The longer you reside in Australia and establish closer economic ties you’ll have even more consideration towards your American tax filing.

You may also need to report any foreign financial accounts and assets acquired during your stay. Generally, U.S. taxpayers in Australia with more than $10,000 in a foreign bank or financial accounts (for example, superannuation accounts) are bound by FBAR filing and reporting requirements. You can also be subject to FATCA reporting requirements if you have assets that are valued at $200,000 or higher.

There Are an Estimated 105,000 Americans Living in Australia

All citizens and green card holders from the U.S. whose worldwide income exceeds the IRS’ current minimum thresholds will be required to file a U.S. federal tax return and to pay any taxes to the IRS, no matter where they live or whose income is generated.

Australia’s Taxes at a Glance

You should know a few things about Australia’s taxation process. The essential need-to-know is:

Tax Rates for Australia

Like the U.S., Australia uses a marginal tax rate that is based on a progressive tax system; for example, tax rates for an individual increase as one’s income rises. The present highest marginal tax rate for residents is set at 45%, but that is not without an additional 2% Medicare levy. Differently from the U.S., income taxes in Australia are most often imposed at the federal level but not at levels relating to state or local.

Also, similar to the U.S., all Australian taxpayers are required by tax law to file an income tax return annually with the Australian Tax Office (or ATO). The Australian tax year ends on June 30, unlike the U.S.’s on December 31. Also, Australia’s individual income tax return is required to be “lodged” (i.e., filed) by October 31; in the case of emergencies and such, extensions are available.

Australia has a progressive tax system; the more your income is, the more you will have to pay.

You can also earn up to $18,200 in a financial year and not have to pay taxes. This is known as the tax-free threshold, after which the tax rates kick in.

The lowest rate is 19%, and the highest rate is 45%, which is only charged on income over $180,000. Most Australians sit in the middle bracket.

For the 2022/2023 tax year, all Australian residents shall expect to be taxed on all income over $18,200, no matter where it’s earned.

Non-residents are taxed on all Australian-sourced income, with some exceptions.

What Types of Taxation Does Australia Have?

With everything mentioned above, let’s get into the various kinds of taxes to expect or keep in mind.

Australian Resident Income Tax Rates

The income tax rates for residents are different from that of a non-resident.

Similar to US taxes, the percentage of tax you pay increases as your income increases. However, the rate ranges are steeper for non-residents, as shown below.

Resident Tax Rates 2022-2023

Tax Rate	Income
0%	0-A$18,200
19%	A$18,201-A$45,000
A$5,092 with an additional 32.5%	A$45,001-A$120,000
A$29,467 with an additional 37%	A$120,001-A$180,000
A$51,667 with an additional 45%	A$180,001 and up

Foreign Resident Tax Rates

Tax rates for foreign residents for the 2021/22 and the 2022/23 year are:

Taxable income $	Tax payable $
0 – 120,000	32.5%
120,001 – 180,000	39,000 + 37% of excess over 120,000
180,001+	61,200 + 45% of excess over $180,000

Capital Gains Tax

Capital gains are taxed in Australia but are considered part of the standard income tax instead of a separate category. Because of that, capital gains are therefore taxed at the same rates as one’s income.

However, Australia’s capital gains tax does not apply to assets received through an estate transference, and capital gains can only be incurred if you sell the asset you acquired later on.

Goods and Services Tax

The Goods and Services Tax (also known as GST) is a value-added tax that can be applied to most goods and services transactions, even if relating to goods and services and can be applied at a flat rate of 10%.

Corporate Tax

In Australia, domestic companies don’t always have to be incorporated, so they can be considered as a corporation to reach specific tax purposes. All that is necessary from the company is that it carries out business in Australia, along with Australian ownership or control.

All companies in Australia are also subject to a federal tax rate of 30% upon their taxable income. The exception would be for ‘small or medium business’ companies, usually subjected to a reduced tax rate of 25%.

Social Security

Let’s examine the following key points surrounding the basics of Australian Social Security:

Do I Need to Pay Social Security in Australia?

- - If a U.S. company has assigned you to work in Australia for less than five years, you will pay into U.S. Social Security;
  - If the assignment timeline goes over five years, you will need to pay towards the Australian social security; and
  - If you are working for an Australian employer located in Australia, you will pay towards the Australian social security (contact your local AOT) for information).

Australia’s Social Security Agreement with the United States

Like the U.S., Australia has a social security system so that it can best provide for its citizens and residents. Even a secured system can still confuse expatriates over which system they should contribute to while residing in Australia. Fortunately, the U.S.-Australia totalization agreement establishes rules for social security contributions.

Self-employed Americans living abroad in Australia may choose to contribute to either social security system.

Superannuation

Defined as a payment by an employee towards a fund that can evolve in the future as a pension, superannuation can serve Australian taxation for the purposes listed below.

Superannuation Reporting is Important

Superannuation funds can make filing expatriate taxes extra complicated. Anyone who has control over these funds will encounter additional IRS reporting requirements.

How to treat Australian superannuation contributions for your expat tax return?

The IRS treats these funds as grantor or employee benefit trusts, so they are not recognized qualified retirement plans, though they operate very similarly to a 401(k).

Asena advisors. We protect Wealth.

Living as an Expat in Australia

Moving to Australia but still having tax residency/citizenship status in another country (including the United States) can lead to questions about filing for both. Let’s look at the overall question below:

Do I Need to File 2 Income Tax Returns – Both US and Australia?

If you’re an American working or residing in Australia for some time (short or permanent), you should assume you have an income tax return obligation in both the U.S. and Australia.

If you’re an American working in Australia, you may also have to file Australian taxes based on your residency and domicile status. Where Australian taxes are concerned, your domicile is generally where you have your permanent home, and your tax residency is where you spend most of your time. You can be a resident in more than one country, but you can only have one domicile.

How do U.S. Expat Taxes Work While You Live and Work in Australia?

Here is what American expatriates can expect from both U.S. and Australian tax laws about living and working in Australia:

Americans Who Are Self-Employed in Australia

It is required by Australia’s tax law to file a U.S. income tax return in the case that you have net earnings worth $400 or more from self-employment, regardless of age. You are required to pay self-employment tax onto your self-employment income, no matter if it can be excludable as foreign earned income in figuring your income tax.

Does Australia tax foreign income?

The Australian income tax system taxes its residents based on their worldwide income (i.e., whether the income is earned within or outside Australia).

Generally, non-resident individuals are only required to pay tax to the ATO on an Australian-sourced income. However, unlike the U.S., individuals that have become residents in Australia for a short time may be eligible for a temporary resident tax exemption on their foreign income and capital gains.

What is the Income Tax Rate in Australia Compared to the U.S.?

Current Australian income tax rates are relatively high compared to the U.S., which is 37%. Australian tax rates vary depending on your taxable income and between 0% – 45%,

When is My Australian Income Tax Return Due?

Australia’s tax year starts on July 1 each year and ends the following year on June 30. The deadline to lodge (file) your taxes is October 31.

U.S. Taxes – What You Need to Know

If you earned over U.S. $12,550 (per individual) in 2021 (or $12,400 in 2020), have $400 of self-employment income, or only have a minimum of $5 of any income if you are married to (but happen to be filing separately) from a foreigner, it is a requirement to file Form 1040. While taxes owed are due on April 15, expats are able to get an automatic filing extension until the deadline of June 15, which can be extended further online on request until October 15.

If you have foreign assets valued at over U.S. $200,000 (per person, excluding your home if it is owned under your name), you must also file a Form 8938 to declare them.

If you had over U.S. $10,000 in one or multiple foreign bank accounts during the tax year at any time, it would be necessary for you to file FinCEN form 114, also known as an FBAR (Foreign Bank Account Report).

If you are paying any income tax in Australia, several IRS provisions allow you to avoid paying double tax onto the same income in the U.S.

The two primary provisions are the Foreign Earned Income Exclusion, as it lets you exclude the first US$110,000 income earned from U.S. tax, and the Foreign Tax Credit. This gives you a U.S. tax credit to offset the tax you already have paid in Australia.

The Foreign Tax Credit is a more beneficial option for American expats who find themselves paying more tax in Australia than they would in the U.S. They can carry any excess U.S. tax credits forward for any future use. No matter if you don’t owe any tax in the U.S., you will still have to file if your income exceeds the IRS minimum thresholds.

Does the U.S. Have a Tax Treaty with Australia?

Yes, the U.S.-Australia Income Tax Treaty was signed in late 1982 and later entered into force a year later in 1983

The U.S. – Australia Tax Treaty

However, the U.S. – Australia Tax Treaty doesn’t prevent U.S. expats living in Australia from having to file U.S. expat taxes. It contains provisions that can benefit some U.S. expats in Australia, such as students and individuals who will be given retirement income.

Most kinds of income are set out in the Treaty for U.S. expats so that they can avoid double taxation of their income arising in Australia. One way is to claim U.S. tax credits towards the same value as Australian taxes that have already been paid on their income by claiming the IRS Foreign Tax Credit.

If they have income arising in the U.S., U.S. expats in Australia can claim Australian tax credits against any U.S. income tax paid to the IRS when they file their Australian tax return.

The Treaty also covers any corporation taxation, stating that a company shall only be taxed in the country which it is registered under. An exception would be a ‘permanent establishment’ (an office, branch, factory, etc.) in another country. In that case, the permanent establishment’s profits shall be taxed within the country where it is located.

It’s also worth mentioning that the Treaty contains a clause that allows the two countries to share tax information; in other words, the IRS can see the Australian taxes U.S. expats currently residing in Australia are paying and vice versa.

Australian banks also share their U.S. account holders’ contact and balance info with the U.S. Treasury.

To claim a provision in the Tax Treaty (besides claiming U.S. tax credits), expats should use IRS form 8833.

What are Australia’s Taxes Like for U.S. Expats?

For the 2022/2023 tax year, all Australian residents are expected to be taxed on all income over $18,200, regardless of where it’s earned. Also, non-residents are taxed on all Australian-sourced income, with some exceptions.

Australian Pension Plans

Superannuation is considered to be Australia’s version of a pension system, as superannuation is partly mandatory and voluntary. Excluding salary and wages, the government has minimums employers and employees must meet to fulfill superannuation requirements. The current rate is 9.5%, which will increase to 12% by 2025.

Employee investments are both funded and vested.

Superannuation funds can make filing U.S. expat taxes extra complicated. The IRS treats these funds as grantor or employee benefit trusts, so they are not considered to be qualified retirement plans; they also operate similarly to a 401(k). Anyone who has authority over these funds will encounter additional IRS reporting requirements.

The U.S.-Australia Totalization Agreement

This agreement influences most tax payments and benefits under their respective social security systems due to it being designed to eliminate dual social security taxation. This situation occurs when a worker from one country relocates (digitally or in-person) to another country to work and is required to pay social security taxes to both countries (IRS and ATO) on the same earnings. It’s also good to fill gaps in benefit protection for all workers who have divided their careers between the United States and Australia.

What Tax Forms do Americans Living in Australia Have to File?

The most common forms to file as a U.S. expat include the following:

Foreign Bank and Financial Account Report (FBAR): it should not be considered a tax form and is not filed with the IRS. Instead, it is an informational form submitted to the U.S. Treasury Department. Any U.S. account holder (either person or entity) with a financial interest in or has signature power over one or more foreign financial accounts with more than $10,000 in aggregate value in a calendar year must file the FBAR annually with the Treasury Department.
Form 8938, Statement of Specified Foreign Financial Assets (FATCA Reporting): If you reside outside the U.S. and have a bank account or investment income account with a foreign financial institution, you will be required to include FATCA Form 8938 along with your U.S. federal income tax return if you meet certain monetary thresholds.

U.S. Tax Forms for Expats in Australia

- FinCEN Form 114: Report of Foreign Bank and Financial Accounts (FBAR)
- Form 1040: Individual Income Tax Return
- IRS Form 8938: Statement of Specified Foreign Financial Assets (FATCA)

U.S. Tax Reporting Considerations

U.S. expats who possess accounts or other overseas assets can be subject to several specific filing requirements in the structure of informational forms. Some forms need to be submitted to the IRS as attachments onto the personal income tax return (Form 1040), while others can be submitted to other governmental departments. Failing to file any of the proceeding forms will result in severe civil penalties, such as a $10,000 per form per year. Additionally, criminal penalties, including fines and incarceration, may apply in certain extreme cases if the reporting delinquency is shown to be willful.

Australia Expat Income Taxes

There are a few standard expectations when paying taxes for Australian-sourced income, such as:

Who is Liable for Income Taxes in Australia?

For the 2022/2023 tax year, all Australian residents are expected to be taxed on all income over $18,200, no matter where it’s earned. Non-residents are taxed on all Australian-sourced income, with some exceptions.

Who is an Australian Tax Resident

You can qualify as an Australian resident if you’re domiciled in Australia or spent more than half of the tax year without a permanent home residing elsewhere. Additionally, you also may be a resident if you happen to be an “eligible employee” of a superannuation fund.

Tax Year in Australia and Tax Filing and Payment Rules

Unlike in the U.S., the Australian tax year starts on July 1 and ends on June 30 of the following calendar year. The official deadline for filing an Australian income tax return is October 31, after the end of the country’s tax year.

Extensions are available for taxpayers in certain situations for exceptional and unforeseen circumstances, such as those affected by natural disasters or even those who volunteered to aid victims of natural disasters.

If you hire a registered tax agent before October 31, the filing deadline is automatically extended to June 5 of the following year.

Expat Tax Withholding in Australia

When U.S. Expats start working as an employee in Australia, they pay income tax on payments received from their employers. The U.S. Expats’ employers deduct tax from your pay and send those amounts to us.

As an expat your employer withholds tax on your behalf from your salary or wages. Your employer will use your TFN declaration to work out how much taxes will be withheld from your pay.

Who Qualifies for a Resident of Australia?

If you’re domiciled in Australia, you qualify as a permanent resident of Australia or spent more than half of the tax year without a permanent home elsewhere. Additionally, permanent residents may be “eligible employees” of a superannuation fund.

What is the Implication of Being a Self-Employed American in Australia?

All U.S. expats are required to file a U.S. income tax return if your net earnings are $400 or more from self-employment, regardless of age. You must also pay self-employment tax onto your self-employment income, no matter if it is excludable as a foreign-earned income when calculating your income tax. Any net earnings from self-employment include the income earned in Australia and the United States.

What You Need to Know about Living and Working in Australia for Your U.S. Expat Tax Return

Along with standard expectations, some common dos and don’ts come with being an Australia-residing expatriate are:

Common Mistake

Of particular importance is that U.S. expats, more often than not, mistakenly assume that once they have moved abroad, any U.S. tax obligations will cease to exist.

So much so that, as a basic rule, all U.S. citizens, even those residing outside the United States, will be recognized as U.S. residents for tax purposes. Therefore, they are subject to U.S. tax reporting on their worldwide income and can be held towards tax liability if unable to report all current tax information.

Australia Foreign Bank Account

Suppose you reside outside the U.S. and possess a bank account or investment account in a foreign financial institution. In that case, it is necessary to have FATCA Form 8938 included with your U.S. federal income tax return so you can meet certain monetary thresholds.

Additional Child Tax Credit for American Families in Australia

American expatriate families living in Australia should know the benefits they can receive from the Additional Child Tax Credit.

Australia is a country that has a higher income tax rate than the U.S., so Americans residing abroad in Australia can use the Foreign Tax Credit way instead of the Foreign Earned Income Exclusion. They can also then receive up to $1,400 per qualified child per year.

A qualifying child must be dependent on you, is under 17 years old, and has a valid Social Security Number.

We have met families who made up for lost years of tax filing through our Streamlined Procedure and were surprised to receive up to $3,000 of refunds every year when they claim the child tax credit.

What Tax Deductions are Available for Expats Living in Australia?

Because of the Treaty, most Americans residing in Australia already have an exemption from double taxation. However, the IRS can also provide several other beneficial tax credits and deductions for expats, such as:

Foreign Housing Exclusion (or Deduction);
Foreign Earned Income Exclusion; and
Foreign Tax Credit.

Most expats who apply these tax credits are able to erase their U.S. tax debt entirely.

Asena Advisors focuses on strategic advice that sets us apart from most wealth management businesses. We protect wealth.

How to Deal with the Different Tax Year in Australia in Your U.S. taxes?

Filing your U.S. tax return is due on June 15 – the automatic, 2-month filing extension for expats. However, you may need to file for the October 15 deadline because Australia has a different tax year.

When you report income as a U.S. citizen in Australia, you cannot use the same tax year in Australia as in the U.S. Both countries have different tax years. Therefore, for filing a U.S. tax return as an expat, you’ll need to calculate your worldwide income according to the U.S. tax year. This tax year is January 1 – December 31.

Due to this, it is recommended to use monthly payslips so you know how much income you receive every month. That way, you can translate what you earned from the Australian tax year to the U.S. tax year.

You `must report your worldwide income and file a U.S. tax return by June 15 every year as an American living abroad in Australia. However, if you are waiting for your second Australia income statement, that may come after the U.S. expatriate filing deadline.

Should I Take the FTC over the FEIE if I Live and Work in Australia?

While Australia’s top marginal rate is at 45%, the U.S. instead charges 37%. And the Australian maximum marginal tax rate starts much earlier. That way, you will be better off ignoring the FEIE but still claiming a full foreign tax credit.

But exercise caution, as you can only claim a new FEIE if six full years have passed since you had last rejected an FEIE. The sole exception for this scenario is if you receive permission from the Internal Revenue Service in order to change back earlier.

You may carry any qualifying unclaimed foreign tax credits for one year and then carry them forward for ten years. However, you can only claim these against other foreign income, so if you return to the States and still have excess foreign tax credits, you can’t use these against U.S.-sourced income.

Use the Foreign Tax Credit to Prevent Double Taxation

If you’d like to avoid double taxation, American expatriates in Australia can apply and use the Foreign Tax Credit. That way, whatever amount of taxes that is owed will be paid in Australia by you and can be applied to your U.S. tax return. That way, you will only have to pay taxes once.

Filing Requirements and U.S. Tax Deadlines

Suppose you are a U.S. citizen or resident, and your tax home and your abode are outside either the United States and/or Puerto Rico upon the regular due date of your return. In that case, you will be automatically granted an extension for June 15 to file your return and pay any tax due. You do not have to file a particular form to receive this extension, and you must attach a statement to your tax return when you file it, showing that you are eligible for this automatic extension.

Qualified Dividends in Australia for your Foreign Corporation or Investment

Resident shareholders in foreign companies can receive credits on distributions. If you happen to own shares within an Australian company and receive a grossed-up dividend report of profits, the company has already paid any and all taxes on a portion of those dividends (as of this posting, the rate is 30%). Australian residents can also receive a rebate (also known as franking or imputation credit) on the tax that has been paid and distributed by that company. Depending on your Australian tax bracket, receiving the entire credit or a portion of the credit is possible.

Selling Your Home in Australia

You need to be aware of some tax implications if you are planning on selling your home in the U.S. or Australia as a U.S. citizen abroad.

As an expat in Australia, you have the ability to claim Section 121 Exclusion and exclude up to $250,000 of profit from U.S. taxation if you file taxes separately (e.g., if your spouse is a non-U.S. citizen). But if filing jointly with another U.S. citizen, you individually can exclude a U.S. $500,000 maximum.

As long as you are qualified under Section 121 Exclusion and its protocols and have lived in your primary house for either two out of five years or owned it for two out of five years, you have the ability to exclude up to $250,000 on your U.S. tax return.

If not, and if the profit when selling the house comes to an estimated $300,000, then $50,000 will be taxable by the IRS. You need to make sure all your tax documents are on a cost basis. The house purchase price includes the cost of renovations, home improvements, etc., so your profit number goes down. Unless you make a significant profit on your home, it is unlikely you will owe U.S. tax for selling your home.

U.S. Tax Benefits are Available to You

Now that we’ve covered the financial and legal aspects that come with being an Australian-residing expatriate, here are some benefits for you to consider:

Foreign Earned Income Exclusion

The Foreign Earned Income Exclusion permits you the ability to exclude your wages from your U.S. taxes. However, this option is only available to those who meet specific time-based residency requirements.

Foreign Housing Exclusion/Deduction

Along with the FEIE, you can also claim a foreign housing deduction or exclusion (applied through Form 2555) for any housing expenses, with the exception of the base housing amount. This exclusion applies to housing paid for with employer-provided amounts similar to a salary, while the deduction can apply to housing that is paid for through self-employment.

Your housing expenses are your reasonable expenses incurred, limited to 30% of your maximum FEIE. High-cost localities like Melbourne, Perth, or Sydney have a higher limit listed in the Instructions for Form 2555. Housing expenses do not include the cost of buying a property, making improvements, or incurring other expenses to increase its value. And your housing expenses can also be within your total foreign-earned income.

The base housing amount is usually 16% of your FEIE.

Foreign Tax Credits

The Foreign Tax Credit permits you to claim a credit for any income taxes that have been paid to a non-domestic government.

Bilateral Agreements

There are two bilateral agreements to be aware of for future research and consideration. They are:

- Double Tax Treaty – U.S./Aus
- Social Security Totalization Agreements

Reach of U.S. Government

Because of FATCA and its Supporting International Agreements have made the U.S. Income Tax Reach more comprehensive than ever before.

FATCA, also recognized as the “Foreign Account Tax Compliance Act,” FATCA is a relatively new tax law enacted in 2010 as an addition to the HIRE Act. The objective behind FATCA since then has been to combat all offshore tax evasion by requiring U.S. citizens to report their holdings residing in foreign financial accounts and any foreign assets to the IRS annually. As part of FATCA’s implementation since the 2011 tax season, it is an IRS requirement that certain U.S. citizens must report (on Form 8938) the total value of any of their “foreign financial assets.”

Starting January 1, 2014, to further enforce FATCA reporting, foreign financial institutions (also known as “FFIs,” which include just about every investment house, foreign bank, and even some foreign insurance companies) must report all account balances held by U.S. citizen customers. To date, several large foreign banks have required that all U.S. citizens who have maintained accounts with them (the large foreign banks) to provide a Form W-9 (a form to declare their status as U.S. citizens) and to sign a confidentiality waiver agreement where they grant permission to the bank to provide the IRS all information about their account. There are cases where foreign banks have closed the accounts of U.S. expats who refuse to cooperate with the requirements.

This renewed effort by the U.S. government to combat offshore tax evasion through FATCA has led to a recent surge in tax compliance efforts by U.S. expats.

Recently, the IRS announced that the United States had signed a so-called competent authority arrangement (“CAA”) with Australia in furtherance of a previously signed intergovernmental agreement (“IGA”) with Australia. This agreement is designed to promote the implementation of the FATCA tax law requiring financial institutions (mainly banks and investment houses) outside the U.S. to report information on financial accounts held by their U.S. customers to the IRS.

Suppose you are a U.S. expatriate living in Australia. In that case, you must remain compliant with your continuing U.S. tax obligations and contact your local ATO for tax services and questions.

Our experts at Asena Family Office are available to help you understand your U.S. tax filing requirements and assist you with your U.S. tax compliance needs.

–Shaun Eastman

–Peter Harper

Multi-Member LLC

Posted on November 30, 2022October 26, 2023 by Peter Harper

Multi-Member LLC

In our previous articles, we have discussed the single-member LLC and the advantages and disadvantages of owning and operating such an entity, not to mention its default tax treatment. Today, we will be discussing what it means to form and control a multi-member LLC (MMLLC), which is simply a limited liability company with more than one member.

Understanding Multi-Member LLCs?

While there are similarities between a single-member LLC (SMLLC) and an MMLLC, there are also many differences. But before we elaborate on the details and differences between the two, it may be beneficial to talk more about the history of this entity type.

History of Multi-Member LLC

Even though the first state to authorize the creation of the LLC was Wyoming in 1977, it was in 1996 that all 50 states in the U.S. had LLC statutes. Through Revenue Ruling 88-76, the IRS decided in 1988 that Wyoming LLCs were taxable as partnerships. And even today, this is the default tax treatment of an LLC with more than one member – a partnership.

What is a Multi-Member LLC?

This type of LLC has two or more owners ( or members) that share control of the company. Unless electing S Corporation tax treatment, there can be an unlimited quantity of members within a multi member LLC. The LLC may also decide on how (and what percentage of) profits and losses shall be distributed among its members, customarily done through its operating agreement.

Who Can Form a Multi-Member LLC?

Members can be either individuals, corporations, or even other LLCs.

How Multi-Member LLCs Work

Now that we have discussed a bit about the history of this entity type and what it is, it is time to explain how such entities work.

Ownership

This LLC is comprised of two or more owners ( or members) that share control over the company. The LLC is its own legal entity that is separate from its owners. Unless it decides to elect for S Corporation tax treatment, there could be an unlimited number of members within an MMLLC. The LLC may decide on how (and what percentage of) profits and losses shall be distributed among its members.

Personal Asset Protection

An MMLLC offers asset protection for the owners’ personal assets because it is a separate legal structure. Indeed, the biggest reason why many people form an MMLLC is the limited liability that it offers its owners. Specifically, the owners’ personal assets cannot be appropriated to pay the debts of the LLC. Owners may, however, be held personally responsible within certain situations (such as when they “pierce the corporate veil”), and in this scenario, they would potentially incur personal liability.

Profit Distribution to Owners

MMLLC owners are entitled to a distributive share of the profits in the entity, and typically, these profits are in proportion to the percentage interest each owner has in the company. Using this example, if one member owns 70 percent of a multi-member LLC and another member owns 30 percent, then the first person will be entitled to 70 percent of the company’s profits, and the second person will be entitled to 30 percent of the company’s profits. Since the LLC is a flexible entity structure, you can divide profits and losses by way of a particular allocation using something other than the percentage of membership interest. In this scenario, each member might be entitled to a percentage of profits that is different from their percentage of ownership in the business. However, again, this should be clearly stated. While an LLC is not required to distribute profits to its owners, the entity’s owners will still be on the hook for reporting their share of the LLC profits and then paying tax on these profits.

Income Tax Treatment

The default tax treatment of an MMLLC is similar to that of an SMLLC in that it is a pass-through entity, with the profits being allocated to the owners and thus flowing through to their personal tax returns. How it is different is that instead of the income, expenses, and profits being reported on a Schedule C (as for an SMLLC), the income, expenses, and profits are reported on Form 1065 (partnership tax return), and each member of the LLC receives a Schedule K-1 (and must then report this information on their personal return) reporting their share of the LLC’s profit or loss.

Federal Income Taxes and the Multi-Member LLC

A multi-member LLC’s default federal tax treatment is that of a partnership. And, just like a single-member LLC, an MMLLC does not pay taxes on its business profits. Instead, the owners (members) individually pay tax, which is based on their share of the profits, on their personal returns. As stated in the previous section, an MMLLC is required to file a Form 1065 (partnership return), and each member receives a K-1, on which they will see their profits or losses associated with the partnership. Finally, each member must then report the profits on Schedule E of their personal return Form 1040. In terms of taxes payable, members will need to pay not only federal taxes but also (Social Security and Medicare) on their share of the LLC’s earnings.

You may then decide that you like that an MMLLC is a pass-through entity but that you hate paying so much self-employment tax. In this scenario, the owners could file Form 2553 for the MMLLC to be taxed as an S Corporation, whereby the profits and losses are still passed through to members’ individual returns (filed via Schedule E of Form 1040). However, the difference here is that the owners must only pay a self-employment tax on their wages and salaries, not on their profit distributions. Typically, the owners would pay themselves a salary, and then whatever profit was left over would flow through to their personal returns.

However, an MMLLC’s owners may decide to have the entity not be treated as a partnership. In this scenario, members can elect to have their business taxed as a C-Corp, so the entity will no longer be a pass-through entity. It will pay corporate tax on its profits (presently, the federal corporate tax rate is 21%). To do this, owners must file Form 8832 to change the default tax treatment of the entity.

State Income Taxes and the Multi-Member LLC

This is where things can vary quite a bit. At the state level, tax laws can vary for LLCs. For instance, some states levy fees on LLCs, such as a minimum or franchise tax. Contrary to its name, a franchise tax is not assessed against a business operating as a franchise. A franchise tax is charged to LLCs, corporations, and partnerships into the form of a fee for the concession to form and conduct business in that state.

Who Manages a Multi-Member LLC?

What is excellent about this entity structure is its flexibility. Members of an MMLLC get to decide how it is structured and who manages the entity. Some MMLLCs elect one or more members, or even a third party, to manage the business. This type of MMLLC is called a manager-managed MMLLC. On the other hand, if the LLC members are running the entity equally, the entity is called a member-managed MMLLC.

Involvement

If two or more individuals are managing the company, then you should be able to demonstrate that each manager is involved with the company’s business decisions and operations.

Formation

Multi-member LLC members can be individuals (whether they are Americans or not, and whether they live in the U.S. or not), corporations, or other LLCs. It is important to note that LLCs have organized on a state level, not the federal level.

Compliance

MMLLCs are required to file Form 1065 (unless they elected to be taxed as an S Corporation, which requires a Form 1120-S filing, or a C Corporation, which requires a Form 1120 filing) as well as potentially a state return.

Bankruptcy

When an individual declares bankruptcy, the court possesses the power to seize a large quantity of assets, including those related to the LLC. However, if the LLC is multi-member, the court cannot seize company assets without the unanimous agreement of other LLC members, as this would result in the court taking one person’s assets because of another’s misconduct.

Divorce

There are scenarios in which spouses own a multi-member LLC. Thus, couples often meet in court to divide their assets when a divorce occurs. It is good practice to stipulate how much of the company each member owns (or spouse, in this case). In this scenario, the court may rule that each spouse will retain the share stated in the operating agreement.

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Management Options

Again, one of the best things about an LLC is its flexibility. Thus, with an MMLLC, you can decide how the business is managed.

Member-Managed LLC vs. Manager-Managed LLC

As described previously, in a member-managed LLC, the members participate in running the business. As such, when making big decisions, such as entering into contracts or purchasing expensive equipment, the majority approval of all its members is necessary.

In a manager-managed LLC, on the other hand, the members are able to agree on electing a manager, either one particular LLC member or members, or even a third party, to whom they grant authority to manage the business’ day-to-day decisions and operations.

Basic Steps to Form a Multi Member LLC

While every entity is different, and you may take slightly different steps in forming an entity, the below are best practices and should be followed at a minimum.

Choose a Business Name.

The new LLC name needs to be distinguishable from all other registered entities for tax purposes. You can start searching on the Secretary of State’s business search tool.

Apply for an EIN (Employer Identification Number).

As LLCs are pass-through entities, an application for a new EIN number needs to be obtained if the LLC will be multi-member or if the election is made by its members to be taxed as a corporation.

File Your LLC’s Articles of Organization.

While it may differ from state to state, this document needs to meet articles of organization, such as detailing the name and address of the LLC, the contact details and names of the owners, the application date, and a description of the new business.

Create an Operating Agreement.

This internal document needs to be drafted by members and will set out the rules for ownership and management of the newly formed LLC. It will detail what will happen if additional members are introduced to the LLC, if the LLC will be liquidated, or if members leave the LLC.

Apply for the Necessary Business Licenses and Permits.

Suppose the nature of the business requires the LLC to obtain business licenses or permits to operate. In that case, the relevant agencies need to be contacted to ensure that the licenses or permits are transferred from the sole proprietor to the newly formed LLC.

Open a Separate Bank Account for Your Business.

A bank account for any new business needs to be opened in the name of your LLC to ensure a clear separation between the LLC funds and the members’ personal funds. This also eases the management of assets and allows for more accurate recordkeeping.

Ongoing Compliance Obligations

As with any business entity, owning a multi-member LLC means that there are certain obligations that its members must adhere to. Some of those include renewing any licenses or permits (if required), paying state franchise fees, filing entity tax returns, updating the state the LLC is organized in if there are significant changes, filing an annual report, and so forth.

What are the Benefits of a Multi-Member LLC?

There are numerous benefits to owning an MMLLC. One is limited liability, as an LLC is considered a separate entity from its members. Subsequently, members are not personally liable for the business’s debts and other legal liabilities (i.e., they have limited liability protection). Further, members of LLCs include the business profits in their individual returns because the LLC is classified as a pass-through entity. Additionally, members may be able to apply the 20% pass-through deduction to business profits.

What are the Drawbacks of a Multi-Member LLC?

At the same time, there can be a few drawbacks to having such an entity. Members of LLCs receive units in proportion to their contribution/LLC agreement, and these units are more challenging to transfer than stocks in a corporation. This difficulty in transferring ownership is one of the reasons that external investors/venture capitalists prefer investing in corporations over LLCs.

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Why Should I Have a Multi-Member Operating Agreement?

It could be argued that any entity should have one. Still, it becomes crucial for a multi-member LLC to have an LLC operating agreement, if for no other reason than to avoid ambiguity in the ownership and management structure, profit distribution, and even what happens when/if the company is liquidated or its members leave.

What Should a Multi-Member Operating Agreement Include?

Certain sections are crucial to include. Those include the following:

Article I: Company Formation

This section deals with the formation of the company itself, and it should include information on the list of members and the company’s ownership structure. In addition, it should outline whether the members have equal or different amounts of ownership.

Article II: Capital Contributions

This section covers each member’s initial capital contribution in starting the LLC, whether the contribution is in cash or other assets that are contributed to the business. The total value of the contributions should be clearly listed.

Article III: Profits, Losses, and Distributions

This section describes how profits and losses are allocated (whether they are ownership percentages or some special allocation) and whether the profit distributions are on an annual basis or more often.

Article IV: Management

This section addresses managing the company (whether the firm is member-managed or manager-managed) and how each member will vote, with a transparent system of appointing managers and how individual members will be assigned other specific duties.

Article V: Compensation

This section discusses the topic of compensation. For instance, if the LLC is to be taxed as a corporation, any members can receive a salary for the labor they have performed in the business, along with profit distributions. If the LLC is to be taxed as a partnership, members receive distributions on the basis of their ownership interest in the company.

Article VI: Bookkeeping

The agreement should be clear on whether and which LLC member/members can check the LLC’s books and records, such as financial documents and board meeting minutes.

Article VII: Transfers

This section discusses removing or adding new members to the LLC. Additionally, it states if and when members of the LLC can transfer their ownership in the company. Finally, this section should also clearly specify what happens in the event of death, bankruptcy, or divorce. It cannot be expressed enough on the importance of accounting for these types of scenarios, as, despite everyone’s best efforts, business and life are unpredictable, and in order to protect each member’s share and business interests, these situations and how to handle them should be stated in this document.

Article VIII: Bank Account

This is something that gets overlooked often but is quite apparent. As stated previously, this is essential for any new business to ensure a clear separation between the LLC funds and the members’ personal funds. Additionally, this eases the management of assets and allows for more accurate recordkeeping.

Article IX: Dissolution

This section explains the circumstances if the LLC may be dissolved, and if so, the process of terminating the LLC should all the members vote to end it.

How are Multi-Member LLCs and Their Owners Taxed?

What is the tax status for an MMLLC? A domestic LLC possessing at least two members is usually classified as a partnership for federal tax reasons unless it decides to file Form 8832 to be elected for treatment as a corporation. Each partner must pay taxes separately on the grounds of their operating agreement. Most agreements favor having the taxes corresponding to the membership interest. This means that each LLC member is required to pay taxes on their share of the LLC’s profits whether or not they receive their share of those profits. Unlike a corporation, even if a member or members have the need to leave profits in their LLC for any tax purposes, they can be liable for any income tax for their proportionate share of the LLC’s income. However, as discussed previously, the LLC that is classified as a partnership will be required to file Form 1065, U.S. Return of Partnership Income, with the IRS, as well as provide their members with a K-1 (a breakdown of each member’s profits and losses), and can be subjected to the same filing and reporting requirements as partnerships. Each state could use different tax regulations for an LLC, and the income derived by the LLC and be attributed towards a member or members can be taxed at the state level if it is sourced or derived from that state.

How Do I Pay Myself from a Multi-Member LLC?

You do not get paid a salary as the member/owner of an MMLLC. Instead, you pay yourself by withdrawing the profits made by the LLC as and when needed. This is also referred to as an owner’s draw.

Single-Member vs. Multi-Member LLC

There are numerous differences between an SMLLC and an MMLLC. Some of those differences are discussed below.

LLC taxes

The default tax treatment of an SMLLC is that the owner must report the business’s profits and losses onto a Schedule C of IRS Form 1040 as personal income, and the small business itself does not report or pay taxes independently (nor does it file its own tax return). The LLC owner must also make payments onto self-employment taxes (Social Security and Medicare) on any and all taxable income coming from the business.

An MMLLC, on the other hand, is required to file a return (Form 1065) and provide its members a Schedule K-1 form, which contains information the members will need to file their personal returns. Like with an SMLLC, business owners are subject to federal income tax, FICA taxes, and possibly even state income tax.

Liability protections

Both SMLLCs and MMLLCs have liability protection by default.

Multi-Member LLC vs. Partnership

Even though the default tax treatment for an MMLLC is for it to be taxed as a partnership, there remain differences between an MMLLC versus other entities that may also have more than one member.

Multi-Member LLC vs. LLP

While individuals can own MMLLCs, corporations, and other LLCs, a limited liability partnership (LLP) can only be owned by individuals. Further, in many states, an LLP can only be formed by certain professions, such as doctors and attorneys. On the other hand, multi-member LLCs can be created by and for nearly any profession. Finally, an LLP cannot change its tax classification, whereas MMLLCs can elect to be taxed as a partnership or corporation.

Multi-Member LLC vs. LP

In a limited partnership (LP), general partners have unlimited liability and are personally liable for the business, whereas limited partners receive liability protection. In an MMLLC, all members have liability protection. Further, in an LP, only general partners can manage the business, whereas, in an MMLLC, all members can manage the business.

Is it Better to be a Multi-Member LLC?

Generally speaking, it is more advantageous to be structured as an MMLLC than as an LLP or LP, for the reasons stated in the previous section. However, your needs (or the requirements set forth by your state for your industry/profession) may require you to go with something other than an MMLLC.

Which One is Right for Your Business?

This is a difficult question to answer within the confines of an article. You will have to consider your business’s unique goals, business structure, industry, and profit margin, among other things, to determine which entity type is best. However, this article hopefully elucidates many advantages of a multi-member LLC.

Multi-Member LLC FAQ

Here are some quick additional facts about MMLLCs you should consider:

Does a Multi-Member LLC Need an EIN?

Yes, it does. The entity will need an EIN to do things such as file an income tax return.

Can a Multi-Member LLC become a Single-Member LLC?

Yes, it can. The only official condition is the sale of the membership interest surronding the leaving member(s) towards the remaining member, as well as the filing of a new tax election form.

How Do You Dissolve a Multi-Member LLC?

There are numerous steps you must take in order to ensure that your LLC is properly dissolved. Most MMLLCs will have to perform actions such as:

- voting by members to dissolve the LLC;
- filing a final return;
- filing an Articles of Dissolution with the state the entity is doing business in;
- settling any outstanding debts; and
- distributing assets to LLC owners/members.

For more advice on starting your own multi-member LLC, reserve a consultation with one of our advisors in our Contact Us section to the right.

Arin Vahanian

IRC 674

Posted on November 2, 2022November 14, 2024 by Peter Harper

After covering Section 675 of the Internal Revenue Code, or IRC, in our previous article, let’s go into the next section that clients want to learn more about: IRC Section 674.

What is a Grantor Trust?

Before we begin, let’s start with a simple understanding of what a grantor trust is before going into how financial processes such as IRC can apply to it. Every grantor trust begins with a grantor, defined as any person who either creates a trust, i.e. the settlor, or directly or indirectly makes an excessive property transfer to a trust. A grantor is, therefore, the person with administrative powers to make a gratuitous transfer of their trust property, whether it is the grantor’s estate, trust assets, items of income, or capital gains from an investment.

Hence, a grantor trust is a trust where the grantor has control over the trust to the extent that they will be recognized as the owner/taxpayer of all or any part of the trust for possible federal income tax purposes. That way, they are directly taxed on the income and any other tax attributes belonging to the trust as if it did not exist. The IRS disregards the trust for federal income tax purposes and treats the grantor/primary taxpayer as the deemed owner of the trust assets and trust property included.

What Grantor Trusts Are Used For

Grantor trusts have mainly been used for estate and gift planning purposes to avoid an income tax, gift tax, or estate tax, as well as to best reg trust assets according to the grantor’s wishes. These trusts are sometimes called Intentionally Defective Grantor Trusts (IDGT).

See below for some of the grantor trust methods used by estate planners to reduce and minimize taxes:

- In the case of a revocable grantor trust, probate can be avoided;
- However, an irrevocable trust cannot be changed unless given consent from the beneficiaries involved. The purpose is to reduce or eliminate taxes after the grantor passes, though some, including gift tax if a gift exceeds $15,000;
- As a “leveraging” tool to grow the impact of giving to designated donees such as using a Grantor Retained Annuity Trust (GRAT);
- As a protection structure for trust assets, providing adequate security for particular business interests such as possible creditors or claimants (if the circumstances involve business succession planning).

Funding The Grantor Trust – Who is the Grantor?

Essentially, a trust’s grantor is that trust’s settlor (or ‘notional settlor’). They are defined as any person who either creates a trust, i.e., the settlor, or directly or indirectly will make a gratuitous transfer of a trust property or items of income (grantor’s estate, capital gains, etc.) to a trust and is regarded as the primary funder.

Provisions Triggering Grantor Trust Status

The rules within the Internal Revenue Code’s Subchapter J, Subpart E govern when the trust income is taxable under a grantor trust status to the grantor or another person who is deemed to be the substantial owner of the trust (and, therefore, the primary taxpayer). This rule was designed primarily for federal income tax purposes instead of the trust itself or its beneficiary. Thus, they are granted administrative powers over the trust when the said grantor trust status is recognized and finalized by the IRS.

These provisions for grantor trust status are also contained in IRC 671-679:

IRC 671 – Sets forth the overall principle that if the grantor is recognized as the owner of the trust, then they must include the trust’s income when calculating their taxable income and income tax;
IRC 672 – Sets forth the definitions and rules when applying the grantor trust provisions to a subordinate party;
IRC 673 – 678 sets out the rules to decide when the trust’s existence can be ignored for federal income tax purposes, including if a grantor can reacquire corpus if they substitute the trust corpus with property or asset of similar value, adequate interest, and adequate security;
IRC 679 – sets out the rules to determine when a foreign trust will be regarded under grantor trust status with or without income tax applied.

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IRC Section 674 – Power to Control Beneficial Enjoyment

Now that we understand the general provisions for a grantor trust and what may trigger a status, let’s look more closely at what Section 674 can do for you.

IRC Section 674 General Rule

IRC §674(a) puts forward the general rule for power to control beneficial enjoyment that the grantor will be recognized as the owner of any trust portion concerning the corpus or income’s beneficial enjoyment. Therefore, they are liable to a power of disposition used by either the grantor or a nonadverse party (or, in unique cases, both) without any adverse party’s consent or approval.

Exceptions for Certain Powers

This particular section of the Internal Revenue Code allows certain powers not only for the grantor but for a subordinate party and or the items of interest within a trust, such as beneficiaries, the will, income, and corpus:

Power to Apply Income to Support of a Dependent

Any power to distribute trust income to support a beneficiary the grantor has been deemed or deems themselves legally obligated to support does not automatically trigger the trust as a grantor trust unless it is used for other beneficial interest purposes. This exception applies even if the grantor or the grantor’s spouse holds this power. Support for a beneficiary that may not be included includes premiums and gifts over $15,000, which can be subject to a gift tax. However, the grantor may be exempt from income tax under IRC 677(b).

Power Affecting Beneficial Enjoyment Only After Occurrence of Event

A grantor won’t be recognized as the owner of any portion of the trust established by a such power to affect the trust’s beneficial enjoyment if that power is not exercisable for an extended period of time. Such a period of time should be long enough that, had the postponed power been a reversionary interest stipulated in IRC 673, it would not have triggered grantor trust status (most common periods used are by taxable year). Therefore, control over beneficial enjoyment will not trigger a grantor trust status if the grantor can’t exert it for a period of time. If the power had become a reversionary interest at any point, the trust should have a value of less than 5%. If this happens and to decide if this criterion was met, it is mandatory to determine the prevailing and adequate interest rate and check the applicable IRS Tables under the treasury regulations for confirmation. However, after the expiration of a stated time has occurred, and the power instantly becomes exercisable, the grantor will be recognized as the owner only if they have not relinquished the power earlier.

Power Exercisable Only by Will

A grantor shall not be recognized as a trust’s owner based on a power to alter beneficial interest and enjoyment if they possess a power exercisable only by a will. The only exception is for a power of appointment to accumulated income of the trust by the will if the trust allows the grantor or a nonadverse party to provide mandatory or discretionary accumulation of trust income.

Power to Allocate Among Charitable Beneficiaries

A grantor shall not be recognized as the owner of any portion belonging to a trust if they have the power to decide the beneficial enjoyment of the trust income or trust corpus when the income or corpus is irrevocably payable for a philanthropic purpose by one or more charitable beneficiaries as defined in IRC §170(c).

Power to Distribute Corpus

A grantor shall not be recognized as the owner of a trust based on if they have the power to distribute corpus to beneficiaries of the trust. In contrast, the grantor’s power to dispense the corpus has been subjected to a reasonably definite standard outlined in the trust instrument.

Powers of Distribution Primarily Affecting Only One Beneficiary

The principal and income must be paid to the said beneficiary (or such beneficiary’s estate and any estate tax attached) or to appointees designated by the beneficiary.

Powers of Distribution Affecting More Than One Beneficiary

The principal and income are distributed to such beneficiaries following their respective shares.

Power to Withhold Income Temporarily

A grantor shall not be recognized as the owner of any portion belonging to a trust if they have the power to distribute or apply the trust income to any present beneficiary or to accumulate the trust income if the accrued income and income tax must be paid eventually to one of the following individuals:

- - The beneficiary whom the income was withheld from;
  - The beneficiary’s estate and any estate tax attached;
  - The beneficiary’s designatees;
  - The present income beneficiaries are within one or multiple shares fixed by the trust instrument.

Power to Withhold Income During Disability of a Beneficiary

The grantor shall not be recognized as the trust’s owner merely because they (or a nonadverse party) hold power to distribute income and accumulate and reg income before adding it to a principal during a period of time in which the income beneficiary possesses a legal disability. Furthermore, any income withheld during such periods does not need to be ultimately payable to the income beneficiary or to their estate and any estate tax attached. It may be payable to whomever the trust declares as the recipient of the trust principal.

Power to Allocate Between Corpus and Income

IRC §674(c) catalogs powers that shall not trigger a grantor trust status if they are to or are being held by an independent trustee, who may be given relatively broad powers over beneficial interest and enjoyment without triggering the grantor to be treated as owner.

Some examples are as listed:

- - Power to divide and provide income amongst particular income beneficiaries;
  - Power to build accumulated income without needing to pay the income to a beneficiary whom it was withheld from at any time;
  - Power to invade corpus for particular beneficiaries (including persons who aren’t income beneficiaries).

Exception for Certain Powers of Independent Trustees

An independent trustee can be given broad powers over beneficial enjoyment without triggering owner recognition towards the grantor unless they cannot due to nonfiduciary capacity. Examples are:

- Power over diving and sharing income amongst particular income beneficiaries;
- Power to build accumulated income without needing to pay the income to a beneficiary whom it was withheld from at any time;
- Power to invade corpus for particular beneficiaries (including persons who aren’t income beneficiaries).

Power to Allocate Income If Limited by a Standard

The grantor rules mustn’t be applied to a power solely exercisable (without the consent of any adverse party) by a trustee or trustees who are not the grantor or their spouse (who must still be living with the said grantor. Power to distribute, accumulate, or apportion income for or to one or more beneficiaries, or from, within, or to a class of beneficiaries (even if the conditions of Subsection (b), paragraphs (6) or (7) are satisfied), is restricted by a reasonably definite and external standard that is presented by the trust instrument. However, a power cannot fall within the powers described above if any person uses it to add to two or more beneficiaries or a class of beneficiaries to receive the corpus or income. One exception would be where such an action is to provide for after the adoption or birth of children.

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Commonly Used Exceptions by Practitioners

The above powers and exemptions are pursuant to understanding the benefits and setbacks IRC 674 can provide for individuals surrounding a trust. However, exceptions can affect how much an individual within a specific role can receive their distribution, whether because of limitations due to income tax purposes, the number of roles involved, or if a role is deemed a nonadverse party possesses nonfiduciary capacity within the trust.

Hems

The trustee’s power to make distributions are restricted because of an understandable and absolute standard like health, maintenance, support, or education (HEMS) (IRC Section 674(b)(5)(A));

Single Beneficiary

There is only one current beneficiary belonging to a trust, and the principal and income must be paid to the said beneficiary (or such beneficiary’s estate and any estate tax attached to it) or to any appointees that the beneficiary has decided (IRC Section 674(b)(6));

Pro Rata Shares

The trust possesses two or more beneficiaries, but the principal and income have been distributed to those said beneficiaries based on their relevant shares (IRC Section 674(b)(5)(B));

No Real Control

The grantor nor the grantor’s spouse do not serve as the trust trustee, and less than one-half of trustees are subordinate or related to the grantor (IRC Section 674(c));

Identity of Trustees

Careful consideration should be taken by advisors and estate planners when drafting the trust deed for clients when it comes to rules for any portion of the trust. The central point of this article isn’t just an analysis of typical powers around a grantor trust status. Still, it is also a careful exploration of the identity of the trustees. For instance, if the grantor’s spouse has the co-trustee role, the trust will trigger and become a grantor trust unless an adverse party is a co-trustee. While grantor trust status has many taxable advantages and grants the power of appointment, under the latest tax regime, taxpayers may increasingly prefer to have non-grantor trusts. Careful planning is critical in preventing inadvertent and potentially harmful income tax consequences.

Think that IRC 674 may be for you? Speak with one of our consultants to learn how to proceed forward.

Peter Harper on US Tax – American Kleptocracy

Posted on October 19, 2022August 7, 2023 by Peter Harper

Asena Advisors is proud to present an episode of US Tax, the podcast for Australian accountants with US clients. CEO Peter Harper dives with host Heide Robson into how the United States has become the most popular offshore haven with illicit finances.

Transcript:

Peter Harper: As far as how did a lot of these island nations and tax havens get into trouble, it had nothing to do with their tax rules. Their tax rules in of themselves were completely fine. It was the way that they managed those tax rules in conjunction with their secretive banking practices to effectively hide and laundered by.

[introductory music plays]

Narrator: You’re listening to US Tax; the podcast for Australian accountants with US clients.

Heide Robson: Welcome to Update 33 of US Tax. This is Heide Robson. So now we are back to publishing content that is unique to this podcast here, US Tax. So this podcast, this episode was not published previously somewhere else.

Heide Robson: When I was talking with Peter Harper of Asena Advisors during the last three updates, I asked him about a book. The book is called American Kleptocracy by Casey Mitchell. The full title is American Kleptocracy: How the US Created the World’s Greatest Money Laundering Scheme in History. Amazon quotes the book, “An explosive investigation into how the United States of America built one of the largest illicit offshore finance systems in the world.”

Heide Robson: So I wanted to get Peter’s input on this. And at the time I (had) asked Peter about this book, neither Peter nor I had read it. In fact, the question was unplanned. I didn’t know I was going to ask Peter this (because) my mind sometimes goes off on a tangent. So neither Peter nor I had read the book and we don’t really discuss the book. What had triggered my question to Peter was the blurb on the back of the book. I had read the blurb and let’s just quickly read the beginning of the blurb. It’s quite long, so let’s just read the first one and a half paragraphs and skip some bits to make it shorter.

[transitional music plays]

Narrator: “For years, one country has acted as the greatest offshore haven in the world, attracting hundreds of billions of dollars in illicit finance (that has been) tied directly to corrupt regimes, extremist networks, and the worst the world has to offer. And this one country is the United States of America. American Kleptocracy examines just how the United States’ implosion into a center of global offshoring took place. How states such as Delaware and Nevada perfected the art of the anonymous shell company.”

Heide Robson: So that’s part of the blurb. So this is what triggered my question to Pete, and bear in mind that Peter hadn’t read the blurb. And my question to Peter is, “Do LLCs just help to hide assets, or do they also help to avoid tax? And if the latter, how does that work? How can you avoid tax using an LLC? Is that what this is about?”

[transitional music plays]

Heide Robson: Before we start, please let me just quickly play you the legal disclaimer that Peter Harper has recorded for you.

Peter Harper: So we talk about those complex questions. I want to caution listeners that each case that may come before them will be unique, and it is vital that they consult with someone that has US expertise in order to handle delicate matters. These topics are not simplistic and need experience and proficiency to tackle. So please reach out to us to address any issues that your clients may bring up with the diligence they deserve.

[transitional music plays]

Heide Robson: Here’s Peter’s answer:

Peter Harper: If you’re a conspiracy theorist, which, in every conspiracy theory, there is some truth. But this is the reality of what happened: the US went out with fat (finger) error, and through all this stuff that happened in Switzerland with UBS, and then in Asia with HSBC, you know, the offshore stuff, and applied these very draconian empirical financial laws.

Peter Harper: The US has gone around and set up all these mutual disclosure regimes around extracting information and information sharing, all that type of stuff. But its states, in itself, are not actually bound by those jurisdictions. And then, you’re quite right, the structure of the LLC is kind of hiding in plain sight, right? Because if you’re generating non-US sourced income and you’re a non-US owner, it’s not subject to US taxation.

Heide Robson: So you basically have three buckets: in the first one, you have EFTP. In the second one, you have ECI. And then in the third bucket, you have income that is neither EFTP nor ECI, and this third bucket does not get taxed in the US if you are not a resident of the US. And so you are referring to this third bucket that is not taxed in the US if it flies through an LLC.

Peter Harper: Yeah, correct. So this is the thing: when you think about a US LLC, and this took me a while to wrap my head around, I spent a lot of time thinking through this. I’m like, “Oh, well, you know, there’s automatically got to be this notion or presumption of a US LLC having a US trade or business,” because my first exposure to an LLC and a lot of people is they go, “Ah, it’s a partnership.” And that is true. When you add multiple people together in a US LLC like it is in Australia, there is this presumption when you have a partnership in Australia that it is two people in business with a view of profit, right, that creates this nexus sort of business. In the US, that’s conceptually true, but it’s not guaranteed. In the context of a single-member LLC, categorically, it’s really straightforward; if you don’t have US-sourced income, so (like) you don’t have a US tradeable business with effectively connected income and you’re not generating US FDAP income, there’s no US tax.

Heide Robson: To just kind of guess what structure they are aiming at, it would be a single-member LLC that is then held by a multilayer structure of international shell companies in tax havens. So you would have a single-member LLC that is held by a tiered structure of companies in tax havens. Most likely then, also, with not even a registered shareholder, but just holding certificates, so that it’s very difficult to work out who is actually owning these assets in the LLC, correct?

Peter Harper: Yeah, correct. So what then happened when all these tax havens got hit through the last round, again, the money always looks around the world. And obviously getting bank accounts and all that type of stuff is very different, right? Because you’ve got to go through and deal with anti-monetary (laundering), or AML, policies and all that type of stuff. But just that process of having a legal structure where you’re not concerned about getting access to US banking. And this is where a lot of the European nations and other countries have since kind of paid the heavy price. (And what) really pushed back at America is America’s willingness and desire to regulate the rest of the world, but its unwillingness to let the rest of the world regulate it, right? And I think when you’re the biggest economic gorilla in the room, you get to push a different agenda. But that is absolutely the truth when it comes to wealth structuring that’s driven by confidentiality today.

Heide Robson: So we identified how it might be structured, but the question is what income could actually flow through it. Because I think the main income that is in this third bucket where it’s neither EFTP nor ECI is when you have product businesses selling products from outside the US into the US. Because then you don’t have a US trade or business, you don’t have an FDAP, hence you are in this third bucket.

Heide Robson: But I think as a vehicle for major tax avoidance, I can’t see how it works. Because, for example, if you set up an LLC that is then held by a multi-tiered structure in tax havens and multiple tax havens scattered across the globe. If you have passive income running through that LLC, you have FDAP, hence it’s taxable in the US. Unless, of course, you’re aiming at capital gains, yes. So it would be mainly capital gains then because they would be-

Peter Harper: FDAP has still got to be coming from a US source. Really where, I think, this has gone, right, it should be very, very clear. This is something I can see how it resulted like this, but we’re not in the business of helping this stuff happen is… I think it’s really (that) a lot of this is driven by folks that have got money that may not have paid (the) proper tax. That may have some issues around how it was derived. And so the only way this kind of works as being a tax haven, it’s a tax haven in the sense that you can have non-U.S. sourced income flow into a US structure and flow out of a US structure.

Peter Harper: What the US gives these clients is (that) they give a really high level of confidentiality that they probably used to have in places such as Switzerland and in Hong Kong that they don’t enjoy anymore. And that’s really it. Because if you think about tax havens, if you really think about most tax havens as they used to exist for many, many years, there’s been really strong anti-avoidance provisions that have existed in most major city nations across the world. But so the ability to maintain substantial amounts of capital in offshore tax havens without attribution, you know, it’s not impossible, but it’s been extremely limited over the course of the last 10 to 20 years. So then the people that are storing money there are just… They’re doing it by being dishonest as far as compliant with the rules.

Peter Harper: So I think why a lot of people are saying, you know, they go (and) say, “Is [the] US a tax haven?” They’re thinking about it in the context where they’re saying, “Okay, you’ve got an LLC, you’ve got a foreign owner, you’ve got income coming into an LLC that’s foreign-sourced (and) that’s flowing back out to a foreign owner. Therefore there’s no US taxation.” Now Americans sometimes jam up and say, you know, “Tax haven.” I’m like, “Okay, well, Australia has a whole bunch of rules. They like to take the conduit, foreign income rules. You got foreign-sourced income flowing through a foreign holding company back out to a foreign owner. There’s no Australian tax.”

Peter Harper: So this notion that it’s really a tax haven automatically on its own, I think, just by virtue of the fact you’ve got income flowing out and not being taxed, that’s a bit of a rich statement. I think what is a fair statement is it is that coupled with the rules that each of these states has implemented around confidentiality. And to me, that’s a bigger issue. The confidentiality (and) the rules they have around confidentiality are more of an issue than the tax rules in of themselves. And some of these rules are not too dissimilar from places like the Cook Islands.

Heide Robson: Yes. Now I’m with you, Peter, because I couldn’t see the tax avoidance, because when you have FDAP, for example, you have withholding tax. Yes, the capital gains would not be taxed in the US and hence would be taxed probably nowhere if the whole structure is held in a tax haven. But I agree with you. It’s really the privacy rules that are around these LLCs by the different states who establish these LLCs. That’s really where you can then hide assets; it’s more about hiding assets than avoiding tax, correct?

Peter Harper: Yeah, correct. And I think, really, if you actually survey a lot of the most recent (years), particularly over the last 30 years, as far as how did a lot of these island nations and tax havens get into trouble. It had nothing to do with their tax rules. Their tax rules in of themselves were completely fine. It was the way that they managed those tax rules in conjunction with their secretive banking practices to effectively hide and launder money, right? And I think the concern with America is, “Hey, guys! You guys went around with a sledgehammer and smashed up the whole offshore tax world.” Right, which is fair enough. You think that’s bad guys doing bad things, anti-money laundering basics. But then at the same time, you’re happy with some of your really more Republican-in-nature states to say that, “Come and put your cash over here or your assets over here and no one can know about it.” It was just one of those things, I think that you know, a lot of people, particularly in Europe, feel that it was a very sort of unfair thing.

[transitional music plays]

Heide Robson: Welcome back. So the criticism leveled at US LLCs is not about tax evasion, because when you have assets in the US that earn US-sourced income, usually for FDAP, you pay tax in the US. Not you, but the LLC which holds those assets pay tax in the US.

Heide Robson: So LLCs in this web of illicit finance are not about evading tax, but are about hiding assets. So if you are a dictator or an oligarch or a corrupt official or a money launderer or a drug or illegal weapons dealer, in short, if you have assets that you shouldn’t have, then US LLCs allow you to hide those assets. So your LLC will still be paying tax in the US, but folks back home can’t see where your assets are. So when you look at offshore tax havens, LLCs, and the lot, distinguish between tax evasion and the hiding of assets, tax evasion has become a lot harder with FATCA, the U.S. Foreign Account Tax Compliance Act, and the Common Reporting Standard, CIS, (which is) the equivalent to FATCA for non-U.S. countries. So tax evasion has become a lot harder with FATCA and CIS, but you can still hide assets. And one way to do that is a US LLC.

Heide Robson: So that’s all for today. The next episode will come out soon. We don’t have a set schedule or rhythm for US Tax. It just would get too much to publish each week on Tax Talks, as well as US Tax. Apologies. So we just publish US updates here as they come.

Heide Robson: Thank you for listening. Bye for now and see you in the next update.

[closing music plays]

Got more questions? Speak with one of our consultants at Asena Advisors.

IRC 675

Posted on October 12, 2022November 21, 2023 by Peter Harper

IRC 675

Following our previous articles on grantor trusts, we will cover the first of the three main IRCs: Section 675.

What is an IRC Section 675?

IRC 675 of the Internal Revenue Code, or IRC, involves, under treasury guidelines, the administrative powers of a foreign grantor trust. To be more precise, it states that the grantor of any foreign trust shall be treated as the owner of the foreign trust. This is only true if, under the instruments’ terms of the trust, that specific administrative control can be exercised primarily for the benefit of the grantor instead of the benefit of the beneficiaries.

Additionally, suppose the owner of the foreign trust has the power to amend the administrative provisions of the trust instrument, which would result in him, her, or they becoming the trust owner. If that were to happen, the grantor would be treated as the owner of the trust.

Now that we know the basic understanding of what IRC 675 is, let’s explain its various powers, such as what may cause a foreign trust to become a grantor trust, who the owner of a grantor trust is, and how to toggle grantor trust status.

Sec. 675’s Administrative Powers

The administrative powers under IRC 675 include several different authorities related to administrative duties; notable examples to take note of include voting powers and directing the investment of trust funds, borrowing funds, and the ability to deal with trust income and funds for less than adequate consideration, as well as not having sufficient interest or security.

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General Powers of Administration

When we refer to a general power of administration, this will commonly include the following:

The power to vote or direct voting of a trust’s stock or other securities, where holdings belonging to the grantor or the trust are significantly essential from the viewpoint of voting control.
The power to control the funds’ investment by directing or vetoing proposed any trust investment or reinvestment. Of course, this is only to the extent that the funds consist of corporation stocks or securities, in which the grantor and trust’s holdings are significant from a voting control viewpoint.
The power to reacquire the trust corpus, also known as the sum of money or trust property set aside to produce income of the trust for beneficiaries by substituting other property of an equivalent value.

To summarize our three points above, the perspective through which we need to assess whether a grantor has these powers has to do with controlling funds and assets within a trust.

Borrowing of the Trust Funds

Another power a grantor can possess is the ability to borrow trust funds. For example, we should consider a scenario where the owner can directly or indirectly borrow the corpus or trust’s income and wouldn’t be expected to completely repay any loan, including any interest, before the beginning of the taxable year.

Power to Deal for Less than Adequate and Full Consideration

This particular power is exercisable by the grantor in a nonfiduciary capacity without the approval or consent of another party. It enables the grantor to purchase, exchange, or otherwise deal with or dispose of the corpus or the trust’s income for less than adequate consideration in money or its monetary worth. Specifically, it could allow a grantor to remove assets from the trust for a small amount of deliberation, thus resulting in the grantor being able to terminate that trust completely.

Power to Borrow Without Adequate Interest or Security

This power enables the grantor to borrow the corpus or income, directly or indirectly, without sufficient interest or adequate interest or security except where a trustee, if under a general lending power, is authorized to create loans for any person without regard to said adequate interest or security.

What Are The Grantor Trust Powers?

To summarize the definitions and examples above, here are the most common and vital powers a grantor can have over a trust and its process:

To change or add the beneficiaries of the trust.
To borrow from the trust or a portion of the trust without adequate security.
To use income from the trust in order to pay life insurance premiums.
To change the trust’s composition by substituting assets of equal value.

What Causes Grantor Trust Status?

Now that we know several types of powers a grantor can have, let’s look into what causes a trust to be considered a grantor trust. There are various criteria, but among the most relevant are the following:

IRC § 673(a): the grantor maintains a reversionary interest, meaning that the grantor holds a ‘reversionary interest’ in a trust greater than 5% of the trust principal or income.
IRC § 674: the grantor can control the ‘beneficial enjoyment’ of trust income or assets.
IRC § 675: the grantor maintains administrative control over the trust that can be exercised for his benefit rather than for the trust’s beneficiaries.
IRC § 676: the trust allows the grantor (or a nonadverse party) to revoke any part belonging to a trust and reclaim or take back the trust’s assets later.
IRC § 677(a): if the trust distributes income to the grantor, the trust may be regarded as a grantor trust.
- The grantor will also be treated as the trust’s owner if its income is, or in the owner’s direction, distributed to the owner or the grantor’s spouse. It will also accumulate for any future distribution to the grantor or the grantor’s spouse, or to be applied to payment of insurance policies on either the life of the grantor or the grantor’s spouse.

Additionally, it’s crucial to note that a grantor trust is considered a disregarded entity by the IRS for federal income tax purposes. This will mean that the grantor’s income tax return will include any taxable income or deduction earned by that trust. For the taxpayer’s convenience, the IRS will allow a grantor trust to employ the grantor’s Social Security number (SSN) rather than having a separate tax ID number (TIN).

Also, when discussing what causes grantor trust status, a vital topic to always consider is what grantor trusts’ advantages and disadvantages are. The primary benefit of estate planning is the potential to preserve wealth while minimizing taxes for one’s beneficiaries. That way, beneficiaries will have a lowered tax rate and better prioritization of any estate tax inclusion that may be available. However, a major concern is an assumption that the grantor, as a taxpayer, will have the funds to pay income tax obligations on trust assets and possible interest for the income of the trust during their lifetime. These implications for income tax purposes may cause a grantor to toggle grantor trust status so that the trust is no longer treated as a grantor trust (discussed later in this article). Further, the gift tax is also a concern, so the taxpayer must consider gift tax considerations and tax consequences when creating the trust.

Asena Advisors focuses on strategic advice that sets us apart from most wealth management businesses. We protect wealth.

Who Is Considered the Owner of a Grantor Trust?

The grantor, also known as the owner, settlor, or trustor, is typically the person who creates the trust and contributes property (such as real estate), other funds, or even trust instruments, such as life insurance, to that trust. The trust property and the owner’s funds become part of the trust corpus (in other words, the trust’s assets).

Personal or familial trusts often have only one grantor, but can, along with business trusts, have two or more. For example, if more than one person had funded a grantor trust, each one will be treated as a grantor in proportion to the cash or property value they transferred to.

Suppose a resident of a foreign country is treated as the owner of the trust under the grantor trust rules. In contrast, that specific trust has a domestic civilian or resident as a beneficiary. In that case, the beneficiary will be treated as the trust’s grantor to the extent that the beneficiary made gifts (directly or indirectly) to the foreign owner, irrespective of gift tax applying.

Bear in mind that the grantor is the person who retains the power to control or direct the trust’s income or assets, and is allowed full discretionary protection as the grantor. It’s crucial to understand, especially when dealing with a foreign trust and the income tax consequences surrounding this instrument. Moreover, the owner can also be any person who creates a trust directly or indirectly and makes a gratuitous property transfer to a trust.

How Do I Toggle Grantor Trust Status?

One common question received when looking at IRC 675 is how to toggle a grantor trust status so that the trust will no longer be treated as a grantor trust..

Why would a grantor want to do this? Given that there are implications for income tax purposes of a foreign grantor trust, the grantor may deem it too burdensome to be liable for tax on the income attributable to the trust, year after year. Other common motives include keeping up with the tax rate that comes with their specific grantor trust, or for their own discretionary reasons. Therefore, to terminate the grantor trust status or toggle it off, the powers we explored above (which are often used to create the grantor trust status) must be released or terminated.

How is this done? One possibility this can be accomplished is by transferring power to a specific trustee or a third party, such as a trust protector.

Similarly, to turn the grantor trust status back on after it has been released, the powers released previously must be brought back and given to the previous grantor. This can be done by amending the trust instrument. However, it’s important to remember that a grantor or trustee should never approach this toggling of status flippantly and that professional advice and assistance should be engaged when going down this path.

New Responsibilities With Incorporation

If the grantor trust status terminates during the grantor’s lifetime, and the trust ceases to be a grantor trust, then the grantor is deemed to have transferred the assets to the trust at that time for federal income tax purposes. The question then becomes, does the grantor recognize a taxable transaction or a gain? Assume the trust has non-recourse liabilities to a third party secured by the trust’s assets. If that is true, the grantor will recognize the gain because the grantor will be deemed to have transferred the secured assets to the trust in exchange for a release of liability. In another scenario, the grantor may also recognize capital gain where the trust owes the debt to the grantor because the trust can be received the secured asset from the grantor in exchange for the promissory note to the grantor as of the date that the grantor trust status terminated. However, based on numerous court cases and tax law examples, there appears to be no gain recognized by either the trust or the grantor’s estate at the grantor’s death for income tax purposes.

We will be discussing more on the responsibilities within incorporation in later articles, such as gift tax implications, estate tax inclusion, and creating an irrevocable trust, and where the trust deed is drafted to trigger a certain status intentionally (such as an IDGT, which is an irrevocable trust set up by the owner for this particular purpose).

Speak with one of our consultants to see how IRC 675 can help your financial case.

Arin Vahanian

US-AU DTA: Article 18 – Pensions, Annuities, Alimony and Child Support

Posted on May 18, 2022December 5, 2022 by Peter Harper

Background

The background of this week’s blog is a bit different from the previous ones due to the unique nature of the topic. This week we will be looking at Article 18 of the DTA – Pensions, Annuities, Alimony, and Child Support, which affects a much broader demographic than other articles. The background focuses more on the global economy and financial markets, but there is a reason for this.

Most people start saving for their retirement when they earn their first salary. Contributions are made monthly (either by yourself or on your behalf) towards a Pension Fund (IRA, 401k, super, etc.) and are invested in various classes of assets. We diversify investments to reduce risk and maximize continuous growth, and it gives people a sense of comfort and security to invest in their future via a Pension Fund.

Asena Advisors is the only multi-disciplinary (Accounting and Legal) international CPA firm in the United States that specializes in U.S. -Australia taxation.

In recent months, the world has contended with the emergence of the Omicron variant, central bank policy tightening, and persistent inflation. And most recently, Russia’s invasion of Ukraine has ignited a geopolitical crisis that is shaking global financial markets to their core.

As tensions continue to mount in Eastern Europe, the concern about what is to come has led to some people impulsively cashing out their retirement portfolios or reviewing them.

I’ve always been a great admirer of Warren Buffet and his quotes on investments.

So just to lay the foundation for this week’s blog, I thought I would share two relevant quotes about the current economic climate.

“The most important quality for an investor is temperament, not intellect.”

“Uncertainty actually is the friend of the buyer of long-term values.”

Humans are, by nature, irrational beings and are often tempted to make trades when they think the market is working against them, whereas in contrast, it is the well-tempered investor that learns not to watch the market. This person ultimately ends up reaping the most rewards over the long term.

Their investment philosophy is that you don’t need to have an extremely high I.Q. to build more wealth, but rather that you should be more disciplined with your reaction toward the market’s irrationality.

Now to link the background with the rest of the blog to follow, if you are a U.S. resident with an Australian pension or vice versa, prior to considering whether to cash out your pension or not, make sure you take a step back and instead make sure you understand the potential adverse tax implications of having an international pension fund.

Introduction

The purpose of the Australian treaty is to prevent double taxation and fiscal evasion.

Because the U.S. does not tax contributions or accumulated earnings, and Australia does not tax the distribution of benefits, a U.S. resident could perceivably relocate from the U.S. to Australia and never pay income tax on contributions, accumulated earnings, or the payment of pension benefits that accrued while the employee worked in the U.S. To prevent this issue, the two countries formed a double taxation agreement.

Interpreting Article 18 of The DTA – Pensions, Annuities, Alimony, and Child Support

Article 18 addresses the taxation of cross-border pensions and annuities. Subject to Article 19, pensions and other similar remuneration paid to an individual who is a resident of one Contracting State in connection with past employment shall be taxable only in that State.

Article 18(4)

defines the term’ pensions and other similar remuneration, as used in this Article, to mean ‘periodic payments made by reason of retirement or death, in consideration for services rendered, or by way of compensation paid after retirement for injuries received in connection with past employment.’

Article 18(5)

defines the term ‘annuities,’ as used in this Article, to mean ‘stated sums paid periodically at stated times during life, or during a specified or ascertainable number of years, under an obligation to make the payments in return for adequate and full consideration (other than services rendered or to be rendered).’

We are the only multi-disciplinary international CPA firm in the United States that specializes in U.S.– Australia taxation.

Article 18 is critical to any U.S. person who is a beneficiary of an Australian Superannuation Fund for the following reasons:

The U.S. has taxing authority over vested Australian superannuation benefits pursuant to Article 18 of the DTA; and
In the absence of a specific Article dealing with contributions and the annual income derived by pension schemes (as exist in the U.K. treaty), the U.S. retains the right under Article 1 of the DTA to tax contributions and accumulated earnings under its domestic tax laws.

In terms of the IRC, most foreign retirement plans are not considered “qualified plans” under Section 401(a), which means the plans generally do not qualify for tax-deferral treatment.

For a pension plan to be tax-exempt, the plan must satisfy the requirements contained in § 401 Internal Revenue Code 1986 (IRC). Section 401(a) IRC specifically provides that, for a pension plan to be a “qualified plan” (and therefore exempt from tax under § 501 IRC), it must be organized in the U.S. Accordingly, this means that no Australian superannuation plan (whether retail or self-managed) can be a “qualified plan.” (Read our Whitepaper on Taxation of Foreign Pensions for more details)

There are essentially three phases of U.S. tax treatment that need to be looked at when dealing with the taxation of an Australian superannuation plan. I will provide a brief summary of the three phases for this blog, but please review our Whitepaper for more information.

Phase 1 – Contributions

Suppose contributions are made to an Australian superannuation fund after an Australian citizen becomes a U.S. person (or a U.S. citizen becomes an Australian resident). In that case, the contributions will be taxable in the U.S. under § 402(b)(1) IRC.

Phase 2 – Earnings Derived Within A Superannuation Plan After An Australian Citizen Becomes A U.S. Person

Subchapter J contains the general rules concerning estates, trusts, beneficiaries and decedents, specifically the grantor trust rules. While it is critical that an individual assessment of the circumstances of every taxpayer be undertaken, most superannuation plans (or portions thereof) in Australia could be classified as grantor trusts for U.S. tax purposes.

Phase 3 – Distribution of benefits

In our opinion, there are two possible ways in which accrued Australian superannuation benefits (contributions and earnings) may be taxed in the U.S.

The first is that Australian superannuation benefits of a U.S. person will be taxable upon such a person attaining 60 years of age (the Australian retirement age). The taxpayer will first be liable for tax in Australia, but receive foreign tax credits in the U.S. (creditable only against U.S. federal income tax) for the Australian tax paid (which will be nil if the account is in the benefits phase). In the event of any shortfall, they will pay further federal, state, and city income tax (where applicable).

The second view (the alternate view) concerns highly compensated employees (HCE) and the application of § 402(b)(4) IRC. If an employee is a highly compensated U.S. person who is also a member of a foreign pension plan (i.e., an Australian superannuation plan), technically, on a literal reading of § 410(b)(3)(C) IRC, there is a high likelihood that the foreign pension plan will fail the minimum coverage tests because contributions made in favor of non-resident aliens with no US-source income are not included for the purposes of determining whether the coverage tests have been satisfied.

Conclusion

Both Australia and the U.S. recognize the need for their citizens to be able to self-fund their retirement and the importance of having a globally mobile workforce. This is evident when looking at the concessional tax treatment for individuals who maximize superannuation and pension contributions, and the current impact government-supported pension plans have on federal and state budgets.

We are the only multi-disciplinary international CPA firm in the United States that specializes in U.S.– Australia taxation.

The inadequacies in the DTA arise because it approaches Australian superannuation and U.S. pensions as though they are only taxed at one point, which is on distribution.

Unfortunately, unless Article 18 is amended, the adverse tax implications of U.S. migration on a taxpayer’s superannuation benefits may become a determining factor in whether an executive migrates between Australia and the U.S.

So, the current global economic turmoil might be the perfect opportunity to focus on reviewing the tax exposure of your pension fund instead of considering cashing it out.

Our team of International Tax specialists at Asena Advisors will be able to assist you with these complex tax rules that could apply to your pension fund. In times of adversity, you need proper guidance to your specific needs, and our Multi-Family Office will help you find opportunities in uncertain times.

US-AU DTA: Article 17 – Entertainers

Posted on April 20, 2022December 5, 2022 by Peter Harper

INTRODUCTION

In this week’s blog we will be discussing Article 17 of the US/Australia DTA which relates to entertainers and how they are taxed from an international perspective.

In general, Article 17, provides that if a resident of one country derives income in the other country as an entertainer or sports person, some of the income earned may be protected from tax in that other country, but usually not to the same degree as other individuals who are not entertainers or sports person.

What distinguishes entertainers and sportspersons from other individuals who receive income from employment is that by the nature of their work, some entertainers and sportspersons may have the opportunity to earn a large amount of income in a very short period of time.

INTERPRETING ARTICLE 17 OF THE DTA – ENTERTAINERS

Article 17 states that income derived by visiting entertainers and sportspersons from their personal activities as such will be taxed in the country in which the activities are exercised, irrespective of the duration of the visit.

However, where the gross receipts derived by the entertainer from those activities, including expenses reimbursed to the entertainer or borne on the entertainer’s behalf, do not exceed $10,000 or its equivalent in Australian dollars in the year of income, the income will be subject to tax in accordance with Article 14 or Article 15, which deals with independent or dependent personal services, as the case may be.

It should be noted that income derived by producers, directors, technicians and others who are not artists or athletes is taxable in accordance with Article 14 or 15, accordingly. The commentary to the OECD Model Convention indicates that the word “entertainer” extends to activities which involve a political, social, religious or charitable nature, provided entertainment is present.

It does however not extend to a visiting conference speaker or to administrative or support staff. The commentary acknowledges that there may be some uncertainty about whether some persons are entertainers or not, in which case it will be necessary to consider the person’s overall activities.

We are the only multi-disciplinary international CPA firm in the United States that specializes in U.S.– Australia taxation.

Article 17(2) is a safeguarding provision to ensure that income in respect of personal activities exercised by an entertainer, whether received by the entertainer or by another person, is taxed in the country in which the entertainer performs. This is irrespective of whether or not that other person has a “permanent establishment” or “fixed base” in that country.

If it is however established that neither the entertainer nor any person related to him/her participates in any profits of that other person in any manner, the relevant income accruing to that other person shall be taxed in accordance with the provisions of Article 7, 14 or 15, dealing respectively with business profits and income from independent or dependent services, as the case may be.

A legislative instrument has removed the PAYG withholding requirement in relation to entertainers and sportspersons who are US residents when working in Australia. This only applies where the payments relate to entertainment or sports activities carried on in Australia and where the combined payments do not exceed $10,000 or its equivalent in Australian dollars in the year of income..

This legislative instrument applies from 3 April 2014 until 1 October 2024.

A US entertainer who fulfils the contractual obligations of a US employer by performing in Australia, for a salary paid by the employer, is considered to derive “income from personal activities”, within Article 17 of the US/Aus DTA. This is irrespective of the fact whether or not the entertainer is at arm’s length from the US employer. Where the entertainer is paid an annual salary, an apportionment will be necessary to determine the amount applicable to the period of time spent in Australia.

Where the contract for the personal services of a US entertainer in Australia is made between a US resident and an Australian resident, and Article 17(2) of the DTA applies, both the US resident and the entertainer may be taxable in Australia.

The US resident will be liable to tax under Article 17(2) on the taxable income derived by it, and the entertainer may be taxed under Article 17(1) on remuneration derived from the US resident in respect of the personal activities in Australia.

CONCLUSION

For any person interested in tax planning, Article 17 could be a good motivator to start exercising to ensure this Article applies to you. However, that is easier said than done.

Our team of International Tax specialists at Asena Advisors, will be able to assist you with your international tax planning needs to ensure that Article 17 is adhered to by entertainers. Lastly, we will never say no to an autograph.

Our team of International Tax specialists at Asena Advisors, will be able to assist you with submitting the relevant forms in the US and Australia to get access to these relief measures.

US-AU DTA: Article 16 – Limitation of Benefits

Posted on April 13, 2022December 5, 2022 by Peter Harper

INTRODUCTION

In this week’s blog we will be discussing the technical Limitation of Benefits (LoB) Article (Article 16) of the US/Australia DTA.

Article 16 states that, in addition to being a resident of the US or Australia, taxpayers need to satisfy the requirements of Article 16 to obtain the benefits of the DTA.

In particular, the benefits of the DTA are only available if the resident is:

A qualified person (Article 16(2));
Actively engaged in a trade or business (Article 16(3)); or
Entitled to treaty relief because the IRS or ATO makes a determination (Article 16(5)).

The purpose of these restrictions is to prevent residents of third countries from using interposed companies or other entities resident in either Australia or the US to access treaty benefits, also commonly referred to as treaty shopping.

Treaty shopping is the use by residents of third countries of legal entities established in either the US or Australia with a principal purpose of obtaining the benefits of the US/Australia DTA.

INTERPRETING ARTICLE 16 OF THE DTA – LIMITATION OF BENEFITS

Article 16(1) stipulates that except as otherwise provided in Article 16 only residents of the US or Australia for the purposes of the DTA that are qualified persons are entitled to the benefits otherwise available under the DTA.

The benefits otherwise available under the DTA to residents are all limitations on source-based taxation under Article 6 through 15 and Article 17 through 21, the treaty-based relief from double taxation provided by Article 22 (Relief from Double Taxation), and the protection afforded to residents of a Contracting State under Article 23 (Non-discrimination).

The limitation in Article 16 does however not apply where a person is not required to be a resident in order to enjoy the benefits of the DTA. For example, Article 26 (Diplomatic and Consular Privileges) applies to diplomatic and consular privileges regardless of residence.

Article 16(2) lists the eight categories of resident that will constitute a qualified person for a taxable year and thus will be entitled to all benefits of the DTA provided that they otherwise satisfy the requirements for a particular benefit. It is therefore important to note that the tests must be satisfied for each year that benefits under the DTA are sought.

Article 16(2)(a) – Individuals

Article 16(2)(a) states that individual residents of a Contracting State will be a qualified person and hence entitled to rely on the DTA.

However, the definition of US resident in Article 4(1)(b)(ii) excludes citizens who are also a resident of another country with which Australia has a DTA. In addition, an individual that receives income as a nominee on behalf of a third country resident, may be denied the benefits of the DTA due to the beneficial ownership requirement in Article 10 for example, despite meeting the requirement in Article 16(2)(a).

Article 16(2)(b) – Governmental bodies

Article 16(2)(b) states that the Contracting State, any political subdivision or local authority of the state, or any agency or instrumentality of the state will be a qualified person and hence entitled to rely on the DTA.

Article 16(2)(c)(i) – Publicly traded companies

Article 16(2)(c)(i) states that a resident company will be a qualified person in the following circumstances:

Its principal class of shares is listed on a US or Australian stock exchange; and
Those shares are regularly traded on one or more recognized stock exchanges.

Article 16(2)(c)(ii) – Subsidiary companies

Article 16(2)(c)(ii) states that a resident company will be a qualified person if:

At least 50% of the aggregate vote and value of its shares are owned directly or indirectly by five or fewer companies that are qualified persons due to Article 16(2)(c)(i); and
In the case of indirect ownership, each intermediate shareholder is a resident of either the US or Australia.

Article 16(2)(d) – Other listed entities

Article 16(2)(d) states that certain publicly traded entities (other than companies) and entities beneficially owned by certain publicly traded entities or companies may be qualified persons and hence entitled to rely on the DTA.

Article 16(2)(d)(i) – Publicly traded entities

Article 16(2)(d)(i) states that a resident entity that is not an individual or a company is a qualified person if:

The principal class of units is listed or admitted to dealings on US or Australian stock exchange; and
These units are regularly traded on one or more recognized stock exchanges.

Article 16(2)(d)(ii) – Other Entities

Article 16(2)(d)(ii) states that a resident entity that is not an individual or a company will be a qualified person if at least 50% of the beneficial interests in the entity are owned directly or indirectly by five or fewer companies that are a qualified person due to Article 16(2)(c)(i) or publicly owned entities that satisfy the requirements of Article 16(2)(d)(i).

Article 16(2)(e) – Tax exempt organizations

Article 16(2)(e) states that a resident religious, charitable, educational, scientific or other similar organizations is a qualified person if:

It is organized under the laws of the US or Australia; and
Was exclusively established and maintained for a religious, charitable, educational, scientific or other similar purpose.

Asena Advisors is the only multi-disciplinary (Accounting and Legal) international CPA firm in the United States that specializes in U.S. -Australia taxation.

Article 16(2)(f) – Pension funds

Article 16(2)(f) states that a pension fund is a qualified person if:

It is organized under the laws of either the US or Australia;
Established and maintained to provide pensions or similar benefits to employed or self-employed persons pursuant to a plan; and
More than 50% of the beneficiaries, members or participants are individuals resident in either the US or Australia.

Article 16(2)(g) – Unlisted entities

Article 16(2)(g) states that a person other than an individual that is a resident of either the US or Australia is a qualified person and hence entitled to rely on the DTA if both an ownership and base erosion test are satisfied.

However, one or more of the following categories of qualified persons must principally own the unlisted entity directly or indirectly:

Individuals who are residents in the US or Australia (Article 16(2)(a));
Government bodies of the US or Australia (Article 16(2)(b); and
Entities resident in either the US or Australia that satisfy public listing and trading requirements in Article 16(2)(c)(i) and Article 16(2)(d)(i)).

Ownership test — companies

Article 16(2)(g)(i) requires that 50% or more of the aggregate voting power and value of the company must be owned directly or indirectly on at least half the days of the company’s taxable year by certain qualified persons.

Ownership test — trusts/partnerships

Article 16(2)(g)(i) requires that 50% or more of the beneficial interests of entities other than companies must be owned directly or indirectly on at least half the days of the entity’s taxable year by certain qualified persons.

Base erosion test

Article 16(2)(g)(ii) disqualifies a person that satisfies the requirement in Article 16(2)(g)(i) if 50% or more of the unlisted entity’s gross income for the taxable year is paid or accrued (directly or indirectly) to a person or persons who are not residents of either Contracting State in the form of payments deductible for tax purposes in the payer’s state of residence.

Article 16(2)(h) – Headquarters companies

Article 16(2)(h) states that a resident of the US or Australia that is a recognized headquarters company (RHC) for a multinational corporate group (MCG) is a qualified person and hence entitled to rely on the DTA.

A RHC is a US or Australian resident company where:

It has a substantial involvement in the supervision and administration of companies forming the MCG.
The MCG being supervised is engaged in an active business in at least five countries and each company generates at least 10% of the gross income of the MCG.
The gross income from any single country where a MCG member carries on business activities must be less than 50% of the gross income of the MCG.
No more than 25% of the gross income of the RHC can be derived from the other Contracting State.
The supervision and administrative activities for the MCG are carried out by the RHC independently of any other person.
Generally applicable taxation rules apply in its country of residence.
Income derived in the other Contracting State is attributable to the active business activities carried on by MCG members in that state.

Article 16(2)(h)(i) – Supervision and Administration

Article 16(2)(h)(i) requires that to be a RHC, the company must provide in its state of residence a substantial portion of the overall supervision and administration of the MCG.

Article 16(2)(h)(ii) – Active business

Article 16(2)(h)(ii) requires that the MCG supervised by the headquarters company must consist of corporations that are residents in, and engaged in active trades or businesses in, at least five countries. In addition the business activities carried on in each of the five countries (or groupings of countries) must generate at least 10% of the gross income of the MCG

Article 16(2)(h)(iii) – Single country income limitation

Article 16(2)(h)(iii) requires that the business activities carried on in any one country other than the headquarters company’s state of residence must generate less than 50% of the gross income of the MCG. If the gross income requirement under this clause is not met for a taxable year, the taxpayer may satisfy this requirement by averaging the ratios for the four years preceding the taxable year.

Article 16(2)(h)(iv) – Gross income limitation

Article 16(2)(h)(iv) requires that no more than 25% of the headquarters company’s gross income may be derived from the other Contracting State.

Article 16(2)(h)(v) – Independent supervision of MCG

Article 16(2)(h)(v) requires that the headquarters company have and exercise independent discretionary authority to carry out the supervision and administration functions for the MCG.

Article 16(2)(h)(vi) – Taxation rules

Article 16(2)(h)(vi) requires that the headquarters company be subject to the generally applicable income taxation rules in its country of residence.

Article 16(2)(h)(vii) – Income derived from the other Contracting State

Article 16(2)(h)(vii) requires that the income derived in the other Contracting State be derived in connection with or be incidental to the active business activities referred to in Article 16(2)(h)(ii).

Article 16(3) states that a resident of a Contracting State that is not a qualified person under Article 16(2) is a qualified person for certain items of income that are connected to an active trade or business conducted in the other Contracting State.

In broad terms, the benefits of the DTA will be available if the person resident in the US or Australia:

Is engaged in the active conduct of a trade or business in their state of residence;
The income derived in the other Contracting State is derived in connection with or incidental to the trade or business conducted in their state of residence; and
The trade or business activity in the person’s state of residence is substantial in relation to the activity in the state of source of an item of income.

Article 16(3)(a) firstly requires that a resident of the US or Australia must be engaged in the active conduct of a trade or business in their state of residence. However, a business of making or managing investments for the resident’s own personal account is not regarded as an active trade or business unless these activities are banking, insurance or securities activities carried on by a bank, insurance company or a registered, licensed or authorised securities dealer.

Secondly, the income derived in the other Contracting State must be derived in connection with or incidental to the trade or business conducted in the state of residence.

Article 16(3)(b) states that where a person or an associate carries on a trade or business in the other Contracting State which gives to an item of income the trade or business carried on in the state of residence must be substantial in relation to the activity in the state of source of the income.

The substantiality requirement is intended to prevent a narrow case of treaty shopping abuses in which a company attempts to qualify for benefits by engaging in de minimis connected business activities in the treaty country in which it is resident.

The substantiality requirement only applies to income from related parties.

Article 16(3)(c) states that where a person is engaged in the active conduct of a trade of business then the following will be deemed to be part of that activity:

Partnership activities provided the person is a partner, and
Activities of connected persons.

There are three circumstances in which a person will be connected to another person are, firstly, if either person possesses at least 50% of the:

Beneficial interest of the other;
Aggregate vote and value of a company’s shares; or
Beneficial equity interests of the company.

Secondly, if another person possesses directly or indirectly, at least 50% of the:

Beneficial interest;
Aggregate vote and value of a company’s shares; or
Beneficial equity interest in the company in each person.

Thirdly, a person is connected to another person if the relevant facts and circumstances indicate that:

One has control of the other; or
Both are under the control of the same person or persons.

The above rule is of particular importance to holding companies since they will generally not be able to satisfy Article 16(3)(a) due to the fact that they are managing investments for their own account.

Article 16(4) is an anti-avoidance provision and denies the benefits of the DTA where a company has issued shares that entitle the holders to a portion of the income from the other state that is larger than the portion of such income that holders would otherwise receive.

Article 16(5) states that the competent authorities of the US and Australia can grant the benefits of the DTA to a resident of the relevant Contracting State if they are not a qualified person in accordance with Article 16(2). However, to exercise this discretion the IRS or ATO has to determine that the establishment, acquisition or maintenance of such a person and the conduct of its operations did not have the principal purpose of obtaining the benefits of the DTA.

Article 16(6) defines the term “recognized stock exchange” as:

The NASDAQ System owned by the National Association of Securities Dealers and any stock exchange registered with the Securities and Exchange Commission as a national securities exchange for purposes of the Securities Exchange Act of 1934
The Australian Stock Exchange and any other Australian stock exchange recognized as such under Australian law, and
Any other stock exchange agreed upon by the competent authorities of the Contracting States.

Article 16(7) lastly states that nothing in Article 16 restricts, in any manner, the ability of the Contracting States to enact and enforce the anti-avoidance provisions in their domestic tax laws.

CONCLUSION

The Limitation on benefits clause is drafted with the intention of avoiding treaty shopping.

When planning an international structure it is therefore crucial to ensure compliance with Article 16. Failure to plan properly could result in a loss of valuable benefits and can render the structure ineffective.

To achieve optimal results, immediate business concerns of the client should be carefully balanced with the long-term goals to ensure the establishment of activities in the most favorable environment.

Our team of International Tax specialists at Asena Advisors, will be able to assist you with your international tax planning and ensure that Article 16 is adhered to.

Our team of International Tax specialists at Asena Advisors, will be able to assist you with submitting the relevant forms in the US and Australia to get access to these relief measures.

US-AU DTA: Article 15 – Dependent Personal Services

Posted on March 16, 2022December 5, 2022 by Peter Harper

INTRODUCTION

In this week’s blog we will be discussing the tax implication of rendering dependent personal services as stipulated in Article 15 of the US/Australia DTA.

The main purpose of Article 15 is to ensure that income derived by an individual who is a resident of the US or Australia as an employee or director in the other country is taxed appropriately.

In terms of Article 15 the source state will have taxing rights on such income if the individual is present in that state for a certain period of time.

INTERPRETING ARTICLE 15 OF THE DTA – DEPENDENT PERSONAL SERVICES

Article 15(1) sets out the basis upon which the remuneration derived by employees and directors should be taxed. Pensions, annuities, and remuneration of government employees are covered by Article 18 and 19 of the DTA and therefore not covered in terms of Article 15.

Generally, other salaries, wages, directors’ fees, etc derived by a resident of one country from an employment exercise or services performed as a director of a company in the other country will be taxed in that other country.

Article 15(2) includes an exemption from tax in the country being visited where the visits are only for a limited period. The conditions for exemption are:

That the visit or visits not exceed, in the aggregate, 183 days in the year of income of the country visited;
That the remuneration is paid by, or on behalf of, an employer or company who is not a resident of the country being visited, and
That the remuneration is not deductible in determining taxable profits of a permanent establishment, fixed base or a trade or business which the employer or company has in the country being visited.

Where these conditions are met, the remuneration derived in the source state will be taxed only in the country of residence.

Article 15(3) stipulates that income derived from employment aboard a ship or aircraft operated in international traffic is to be taxed in the country of residence of the operator. The US Treasury however explained that under US law, the US taxes such income of a non-resident alien only to the extent it is derived from US sources (i.e. in US territorial waters). This paragraph does not confer an exclusive taxing right.

Article 15(3) does not confer an exclusive taxing right and both countries retain the right to tax their residents and citizens under Art 1(3) of the DTA (Personal scope).

Remuneration derived by US residents from employment in Australia may in terms of Article 15 of the DTA, be taxable in the US rather than Australia if the remuneration is paid in respect of a visit not exceeding 183 days in the year by an employer who is not resident in Australia and has no permanent establishment in Australia.

Asena Advisors is the only multi-disciplinary (Accounting and Legal) international CPA firm in the United States that specializes in U.S. -Australia taxation.

COVID RELIEF

Both the US and Australia implemented certain relief measures for individuals who inadvertently spent more than 183 days in the source due to the Covid pandemic.

US Covid Relief Measures

Days that you were unable to leave the US either because of a medical condition that arose while were in the US or where you were unable to leave the US due to COVID-19 travel disruptions, you may be eligible to exclude up to 60 consecutive days in the US during a certain period.

Australia Covid Relief Measures

The ATO recognized that the Covid pandemic has created a special set of circumstances that need to be taken into account when evaluating the source of the employment income earned by a foreign resident who usually works overseas but instead performed that same foreign employment in Australia. If the remote working arrangement is short term (3 months or less), the income from that employment will not have an Australian source. However, for working arrangements longer than 3 months, an individual’s personal circumstances need to be examined to ascertain if the employment is connected to Australia. Employment income (ie salary or wages) is likely to be determined as having an Australian source if:

- The terms and conditions of the employment contract change;
- The nature of the job changes;
- Work is performed for an Australian entity affiliated with the overseas employer;
- The economic impact or result of the work shifts to Australia;
- The employing entity is in Australia;
- Work is performed with Australian clients;
- The performance of the work depends on the individual being physically present in Australia to complete it;
- Australia becomes the individual’s permanent place of work;
- The individual’s intention towards Australia changes.

Income earned from paid leave (such as annual or holiday leave) while in Australia temporarily does not need to be declared in Australia.

CONCLUSION

Individuals should therefore make sure that they do not unnecessarily file tax returns in the source state if their stay was extended due to Covid related measures.

Our team of International Tax specialists at Asena Advisors, will be able to assist you with submitting the relevant forms in the US and Australia to get access to these relief measures.

US-AU DTA: Article 14 – Independent Personal Services

Posted on March 2, 2022November 19, 2022 by Peter Harper

INTRODUCTION

In this week’s blog we will be discussing the tax implication of rendering Independent Personal Services as stipulated in Article 14 of the US/Australia DTA. Article 14 is luckily far less complex than our previous blogs.

The main purpose of Article 14 is to ensure that income derived by an individual who is a resident of the US or Australia from the performance of personal services in an independent capacity in the other country is taxed appropriately.

INTERPRETING ARTICLE 14 OF THE DTA – INDEPENDENT PERSONAL SERVICES

In terms of US domestic legislation, income earned by a non-resident individual for personal services rendered in the US which are of an independent nature is taxed at a flat rate of 30%.

Income derived by an individual who is a resident of either the US or Australia for rendering independent personal services in the other country will be taxed in that other country in which the services are performed if:

Article 14(a) – the recipient is present in that country for a period or periods aggregating more than 183 days in the year of income (or taxable year) of the country visited, or

Article 14(b) – that person has a ‘fixed base’ regularly available in that country for the purpose of performing their activities, and the income is attributable to activities exercised from that base.

We are the only multi-disciplinary international CPA firm in the United States that specializes in U.S.– Australia taxation.

Only the country of residence can tax this income if neither of the 2 tests above are met. The US Treasury Department noted that its understanding of the term fixed base is similar to the term permanent establishment.

Independent personal services include all personal services performed by an individual for their own account which includes any services performed as a partner in a partnership. This however does not include services performed as a director of a company which will be covered by Article 15 of the DTA – Dependent personal services.

Lastly, it is important to note that these personal services include all independent activities and are not limited to specific professions.

CONCLUSION

The interpretation by courts of Article 14 post COVID will be quite interesting as the way we conduct business has shifted significantly and could perhaps see an amendment to this article in the new future.

Our team of International Tax specialists at Asena Advisors, will be able to guide you on how to interpret and apply Article 14 to your specific circumstances.

US-AU DTA: Article 12 – Royalties

Posted on February 18, 2022November 19, 2022 by Peter Harper

INTRODUCTION

This week we will be taking a closer look at how royalties are dealt with in terms of the US/AUS DTA.

Royalties earned outside of your resident state are generally taxed by the source state on a withholding basis. Under domestic law, a state can require a person to withhold tax on making a payment to another person.

Royalties that are effectively connected with a permanent establishment are taxed either in terms of Article 7 which deals with business profits or Article 14 which deals with Independent Personal Services.

The US/AUS DTA Protocol amended the treatment of royalties to:

reduce the general rate of source country tax on royalties from 10% to 5%;
exclude from the scope of Article12(4) payments for the use of industrial, commercial, or scientific equipment, and
extend the royalties definition to cover additional types of broadcasting media (Article 12(4)(a)(iii)).

INTERPRETING ARTICLE 12 OF THE DTA – ROYALTIES

The purpose of Article 12 is to limit the tax that the source country may impose on royalty payments to beneficial owners in the other country to 5%, however, this limit only applies if the payments are at arm’s length.

Article 12(1) states that royalties may be taxed in the country of residence of the beneficial owner even though derived from sources in the other Contracting State. This confirms Article 1(3) of the DTA that preserves the right of each country to tax its residents.

Article 12(2) stipulates those royalties may also be taxed by the source country but limits the tax to 5% of the gross amount of the royalties.

Article 12, however, does not apply to natural resource royalties, which are taxable in the country of source in terms of Article 6 of the DTA.

Article 12(3) sets out the exclusions and that the reduced withholding tax rate does not apply in the following cases:

1. the beneficial owner has a permanent establishment in the source country;
2. or performs personal services in an independent capacity through a fixed base in the source country, and the property giving rise to the royalties is effectively connected with the permanent establishment or fixed base.

In that event, the royalties will either be taxed as business profits (Article 7) or income from the performance of independent personal services (Article 14).

Article 12(4) is important as it defines the word royalties for purposes of the treaty. The definition of royalty in Art 12(4) comprises of the following three components:

Component 1 – Intellectual property

Article 12(4)(a) includes payments or credits of any kind to the extent that they are considered for the use or right to use any:

(i) copyright, patent, design or model, plan, secret formula or process, trademark or other like property or right

(ii) motion picture films, or

(iii) films or audio or videotapes or disks, or any other means of image or sound reproduction or transmission for use in connection with television, radio, or other broadcasting.

Due to the technological advances made since the DTA was signed, the protocol was amended to reflect these advances more accurately.

For example, due to the Protocol, Article 12(4)(a)(iii) will apply to a payment made by an Australian broadcaster to a US company for the right to transmit a live feed of an entertainment program through satellite or the Internet.

However, on the other hand, Article 12(4)(a)(iii) will not apply to payments made by a retail customer who has subscribed to a satellite television service provided by a US company.

Asena Advisors is the only multi-disciplinary (Accounting and Legal) international CPA firm in the United States that specializes in U.S. -Australia taxation.

Component 2 – Scientific, technical, industrial, or commercial knowledge or information

Article 12(4)(b)(i) states that royalties include payments or credits for scientific, technical, industrial, or commercial knowledge or information (“know-how”) owned by any person.

The specific reference to knowledge or information owned is meant to indicate that the term royalties imply a property right as distinguished from personal services.

This is a very important distinction to understand, so let’s use an example –

An IT specialist who prepares or designs a website for a customer will be considered to perform personal services and the remuneration received will be taxable in terms of either Article 14 (Independent personal services) or Article 15 (Dependent personal services).

However, should the IT specialist supply a pre-existing design to a customer, this will be considered the furnishing of knowledge (know-how) or information and taxed in terms of Article 12?

Article 12(4)(b)(ii) provides that consideration for any assistance of an ancillary and subsidiary nature that enables the application or enjoyment of know-how is also a royalty payment. However, if the service is supplied in connection with the sale of property, Article 12 will not apply.

Article 12(4)(b)(iii) contains a special rule to deal with the situation of a disguised lease of a property right of the type covered Article 12(4)(b).

Component 3 – Disposition of property that is contingent

Article 12(4)(c) provides that, to the extent that income from the disposition of any property or right described in this paragraph is contingent on the productivity or use or further disposition of such property or right, it is a royalty.

Article 12(5) applies where there is a special relationship between the payer of the royalties and the person beneficially entitled to the royalties or between both of them and some other person.

Where this requirement is satisfied, the 5% limitation will only apply to the extent that the royalties do not exceed the amount that might be expected to be agreed upon by independent persons acting at arm’s length. The excess amount will therefore be taxable according to the law of each contracting state but subject to any other provisions of the DTA.

The term special relationship is significantly wider than the term associated enterprise contained in Article 9 and should be read in conjunction with Article 12(5).

Article 12(6) lastly provides special source rules for royalties. In general, a royalty is considered to have its source in a country if paid by the Government, or a resident of that country, or by a company that under domestic law is a resident of that country.

The US Treasury Department explained that a royalty paid by a dual resident company may be eligible for the reduced rate provided in Article 12(2), although a royalty beneficially owned by such a company is not.

CONCLUSION

It is important to take note that a mere accounting entry may be sufficient to attract royalty withholding tax as the definition refers to payments or credits.

To determine whether a payment is a royalty subject to Article 12 or a payment for services within the scope of Article 7, will depend on the purpose of the payment and circumstances of the arrangement been the parties.

The interpretation of Article 12 is going to take center stage in the near future. Due to the pandemic, numerous people across the world started new business ventures based on models that enable them to generate global income while rendering services remotely. The DTA and Protocol were drafted long before anyone knew the pandemic so neither the US nor Australia took this into consideration when the DTA bilateral instrument was agreed upon.

Make sure you understand how Article 12 can impact your new start-up, as you do not want to have non-compliance issues, penalties, or additional tax just due to not understanding Article 12.

We strongly recommend seeking professional advice when it comes to Article 12. As always, our team of International Tax specialists at Asena Advisors will guide you on how to approach and interpret Article 12.

US-AU DTA: Article 11 – Interest

Posted on February 9, 2022December 5, 2022 by Peter Harper

INTRODUCTION

This week we will be taking a closer look at how interest is dealt with in terms of the US/AUS DTA.

Interest earned outside of your resident state is generally taxed by the source state on a withholding basis. Under domestic law a state can require a person to withhold tax on making a payment to another person.

An overly simplified example of how Article 11 (Interest) applies in practice is if a US tax resident earns interest income from Australia. The US has the right to tax the interest earned from sources in Australia. This right is however not exclusive. If Australia also wants to also tax the interest income, it is limited to the amount of tax it can levy in terms of Article 11.

Article 11 of the DTA (Interest) has a dual purpose:

– Firstly, to limit the tax imposed by the source state where the interest arises; and

– Secondly prevents the treaty benefits available where there is an excessive payment of interest arising from a “special relationship”.

INTERPRETING ARTICLE 11 OF THE DTA – INTEREST

Article 11 generally limits the withholding tax that the source country may impose on interest payments to beneficial owners in the other country to 10%.

Article 11(1) states that interest from sources in one of the contracting states to which a resident of the other is beneficially entitled may be taxed in that other country. Hence there is no exclusive right.

A person will be beneficially entitled to interest for purposes of Article 11 if they are the beneficial owner of the interest.

Article 11(2) provides that the source state (country where the interest arises) may also tax the interest that the resident of the other state is beneficially entitled subject to a maximum rate of 10%.

Currently the US has a non-treaty interest withholding tax rate of 30% and Australia has a general interest withholding tax rate of 10%.

Article 11(3) however provides an exemption for interest paid to government bodies and financial institutions subject to the restrictions in Article 11(4).

Article 11(3)(a) states that interest derived by a Contracting State or a political or administrative subdivision or a local authority of the Contracting State is only subject to tax in the State of residence. This exemption extends to interest received by any other body exercising governmental functions.

Article 11(3)(b) states further that interest derived by financial institutions that are unrelated to and dealing wholly independently of the payer are only taxed in the State of residence.

An example of the type of financial institutions that will qualify for the exemption in Art 11(3)(b) are investment banks, brokers, and commercial finance companies

A financial institution will be “unrelated and dealing wholly independently” of the payer of the interest if the financial institution and payer are not treated as Associated Enterprises as stipulated in Article 9.

Article 11(4) operates as a restrictive provision on the exemption provided in Article 11(3).

Article 11(4)(a) stipulates that the exemption in Article 11(3)(b) will not apply, and the interest derived will be taxed at 10% of the gross amount if it arises from back-to-back loans or an arrangement that is economically equivalent.

Article 11(4)(b) preserves the application of the domestic tax law of each State regarding anti-avoidance provisions. Nothing in Article 11 limits the ability of the US to enforce existing anti-avoidance provisions.

Similarly, Australia reserves the right to apply its general anti-avoidance rules where there is a conflict with the provisions of a tax treaty and Article 11(4)(b) extends this power to any anti-avoidance rule.

Article 11(4)(b) further does not limit the ability of Australia or the US to adopt new anti-avoidance provisions.

Article 11(5) defines “interest” to mean interest from:

(a) government securities, bonds, debentures, and any form of indebtedness, and

(b) income subject to the same taxation treatment as income from money lent according to the law of the Contracting State in which the income arises.

However, income dealt with in Article 10 (Dividends) and penalty charges for late payment are not treated as interest.

The exclusion of income dealt with by the Dividends Article, clarifies that Article 10 takes precedence over Article 11 in cases where both Articles can apply.

We are the only multi-disciplinary international CPA firm in the United States that specializes in U.S.– Australia taxation.

Article 11(6) simply states that tax is not payable under Article 11 where the interest income of the person beneficially entitled to it is subject to tax under Article 7 (Business Profits) or Article 14 (Independent Personal Services).

Article 11(7) defines the source of interest, which is a necessary pre-requisite for the Contracting State withholding tax under Article 11(2).

Generally, interest is deemed to arise and hence has its source in the Contracting State where the payer is a resident.

Unfortunately, it is not always that simple or straightforward. For example, if a person paying the interest has a permanent establishment in connection with which the interest is attributable, the interest is deemed to arise in that Contracting State if borne by that permanent establishment. This is irrespective of the fact whether or not the payer of the interest is a resident of one of the contracting states.

Article 11(8) states that, in cases involving special relationships between persons, Article 11 applies only to that portion of the total interest payments between those persons that would have been made absent such special relationships. Any excess amount of interest paid remains taxable according to the laws of the US and Australia, respectively, with due regard to the other provisions of the Convention.

Article 11(9) contains two anti-abuse exceptions to the treatment of interest in paragraphs (1), (2), (3) and (4)

Article 11(9)(a) states that interest paid by a resident of one of the Contracting States to a resident of the other Contracting State that is determined by reference to the profits of the issuer, or an associated enterprise may be taxed at a rate not exceeding 15%.

Article 11(9)(b) states that interest paid on ownership interests in securitization entities may be taxed in accordance with the domestic law, but only to the extent that the interest paid exceeds the normal rate of return on publicly traded debt instruments with a similar risk profile.

This article is specifically included to preserve the US taxation of real estate mortgage investment conduits (REMICs). A REMIC is a US entity that holds a fixed pool of real estate loans and issues debt securities with serial maturities and differing rates of return backed by those loans.

The purpose of Article 11(9)(b) is to permit the US to charge purchasers of REIMIC investments the domestic US tax on residual interests in REMICs.

Article 11(10) is only regarded to be relevant to US withholding tax. It states that where interest incurred by a company resident in one of the Contracting States is deductible in connection with a permanent establishment (Article 5), due to Article 6 (Real property) or Article 13 (Alienation of property) in the other Contracting State and that interest exceeds the interest actually paid, the amount of the excess interest deducted will be deemed to be interest arising in that other Contracting State to which a resident of the first-mentioned Contracting State is beneficially entitled.

Example:

An Australian company carries on business in the US via a permanent establishment (Branch). For US purposes this relates to branch profit tax. The branch incurs interest that is deductible in determining its US profits. However, the interest incurred by the branch is more than the amount of interest actually paid by the branch. Article 11(10) gives the US the right to tax the amount of interest not paid.

CONCLUSION

We would recommend seeking professional advice when it comes to Article 11. As always, our team of International Tax specialists at Asena Advisors, will guide you on how to approach and interpret Article 11.

Our team of International Tax specialists at Asena Advisors, advise numerous clients and corporations on their international structuring and how to make sure it is done in the most tax effective way.

US-AU DTA: Article 7 – Business Profits

Posted on December 22, 2021November 19, 2022 by Peter Harper

INTRODUCTION

Covid has changed the way business is done globally. Two of the most common changes are

– Remote working (Employee sitting in Australia could be working for an employer in the US); and

– The increase in e-commerce businesses and being able to grow and expand these businesses globally without actually leaving the house.

That being said, have you ever as an employer considered what the potential tax implications could be for the company by having employees working remotely?

And does your e-commerce business create a permanent establishment in another country perhaps?

Make sure you have taken proper steps to mitigate any unnecessary tax implications due to the ‘new norm’.

Article 7 is one of the more complex and technical articles in the DTA as it has various components to consider. However, I will try and provide a brief summary of its interpretation.

The first overriding principle of double taxation treaties is that a company resident in one country will not be taxed on its business income in the other State unless it carries on that business in the other country through a Permanent Establishment (PE) situated in that country.

The second principle is that the taxation right of the State where the PE is situated does not extend to income that is not attributable to the PE. The interpretation of these principles has differed from country to country. Some countries have pursued a principle of general force of attraction, which means that all income such as other business profits, dividends, interest and royalties arising from sources in their territory was fully taxable in that country if the beneficiary had a PE there, even though such income was clearly not attributable to that PE.

In this week’s blog we will have a look at Article 7 of the US/AUS DTA and highlight some key aspects.

INTERPRETING ARTICLE 7 OF THE DTA – BUSINESS PROFITS

Article 7 sets out the limits of the source state’s taxing rights in relation to business profits. If an enterprise resident in a contracting state has a Permanent Establishment (PE) in the other state through which it carries on business it can be taxable in that other state, as well as the state of residence. The tax is limited in the source state to no more than the profits attributable to the PE.

Article 7(1) states the basic principle which is that the profits of an Australian enterprise may be taxed in the US only if it carries on business in the US through a permanent establishment and vice versa. In the case of an Australian enterprise, the US can only tax the profits of the enterprise to the extent that they are attributable to the permanent establishment.

It should be noted that dual-resident corporations are excluded from the term “enterprise of one of the Contracting States” by reason of the definition of an Australian or a US corporation contained in Article 3(1)(g) and the definition of residence contained in Article 4. Such dual-resident corporations are treated as a resident of neither country for convention purposes, and therefor denied the benefit of this article and other provisions in the convention.

The phrase ‘business profits of an enterprise’ is critical to the operation of Article 7.

The term ‘profits’ is not defined in the agreement and the question arises as to whether it includes profits which are ordinarily regarded as capital in nature or which are not derived from the carrying on of a business.

Article 3(2) of the DTA provides that, unless the context otherwise requires, a reference to profits of a business is a reference to the taxable income of the business. As capital gains are included in taxable income, the section arguably supports the view that Article 7 applies to capital gains.

The 2006 U.S. Model Treaty Technical Explanation attempts to define business profits more generally in Article 7(1), providing that business profits are ‘income derived from any trade or business’.

Asena Advisors is the only multi-disciplinary (Accounting and Legal) international CPA firm in the United States that specializes in U.S. -Australia taxation.

Article 7(2), which is subject to Article 7(3), provides that the profits to be attributed to a permanent establishment are those, which it might be expected to make if it were an independent enterprise engaged in similar activities under similar conditions. The profits must reflect arm’s length prices. For example, the profits of a branch must be calculated as if it were a separate entity distinct from its head office and on the basis that the branch was dealing wholly independently with its head office.

The practical application of Article 7(2) is not as straightforward as it seems. Quite often, a functional analysis needs to be done to ensure that arm’s length principles are applied properly. This includes the proper characterization of the transaction and the commercial risks undertaken by the enterprise.

Article 7(3) states that expenses that are reasonably connected with the profits of the permanent establishment and would have been deductible if the permanent establishment were an independent entity are deductible. Further, these expenses are deductible whether incurred in the Contracting State in which the permanent establishment is situated or elsewhere including executive and general administrative expenses.

Article 7(4) states that no profits are to be attributed to a permanent establishment by reason of mere purchase by that permanent establishment of goods or merchandise for that enterprise.

Article 7(5) states that unless there is a good and sufficient reason to the contrary, the same method of determining the business profits attributable to a permanent establishment shall be used each year.

Article 7(6) states that where business profits include items of income dealt with in other articles of the Convention the provisions of those other articles override the provisions of this Article.

Categories of income not specifically included in the definition of business profits are subject to the “overlap” rule of Article 7(6), which provides that a treaty article that governs a specific category of income (for example, the article pertaining to interest or dividends) takes precedence over the business profits article. If the item of income is attributable to a permanent establishment, it may ultimately be taxed under the business profits article anyway, because many of the treaty articles addressing specific categories of income (such as dividends and interest) provide that if the income is attributable to a permanent establishment, it is subject to taxation under the business profits article.

Article 7(7) allows the ATO and IRS to apply any of its domestic laws to determine a person’s tax liability where the information required to make an appropriate attribution of profits to a permanent establishment is inadequate.

Article 7(8) provides that nothing in Article 7 prevents each country from applying its domestic law to tax insurance business income provided that such law remains the same (or is modified in only minor respects) since the date the Convention was signed. or will tax the net income of a US trade or business.

Article 7(9) applies where a fiscally transparent entity, such as a trust, has a permanent establishment in a Contracting State and a resident of the other Contracting State is beneficially entitled to a share of the business profits (beneficial owner).

Where the above requirement is satisfied then the beneficial owner is treated as carrying on a business through the permanent establishment in the Contracting State and therefore its share of the business profits of the fiscally transparent entity are taxable due to Article 7(1).

For example, if a trust with a US beneficiary carries on a business in Australia through its trustee, and that trustee’s actions rise to the level of a permanent establishment then the US beneficiary will be treated as having a permanent establishment in Australia. This has the consequence that the profits of the trust attributable to the US beneficiary will be treated as business profits subject to Australian tax.

Article 7(9) was introduced at the request of Australia because the trustees of a trust, as the legal owner of the trust property, might be regarded as the only person having a permanent establishment.

CONCLUSION

This article is probably one of the more difficult articles to comprehend in the DTA. For purposes of this blog, it’s important to know that a source country can’t attribute any business profits in terms of Article 7 if there is no permanent establishment in that source country.

Our diverse team of International Tax specialists at Asena Advisors, will be able to assist you with applying this article correctly and how to accurately attribute profits to a permanent establishment.

US-AU DTA: Article 6 – Income from Real Property

Posted on November 24, 2021November 19, 2022 by Peter Harper

INTRODUCTION

Almost everyone dreams of one day owning their own holiday home, which they can use switch off and relax. For those dreamers with aspirations, it usually materializes through hard work and dedication.

In practice, we often have client who are US residents with real properties situated in Australia or Australian residents with real properties situated in the US. The purpose of investing in foreign real property will not always be the same.

However, in terms of Article 6 of the US/Australia DTA (Income from Real Property) the tax treatment will be the same. Article 6 is in reality a sourcing provision, which means that the country where the real property is situated, will have the primary taxing rights. This aligns with both Australia and US domestic law, where income from real property is treated as being sourced where the real property is located.

In this week’s blog we will be looking at the tax implications in the context of Article 6 of the US/Australia DTA when earning income from real property situated in the other jurisdiction.

INTERPRETING ARTICLE 6 OF THE DTA – INCOME FROM REAL PROPERTY

Article 6 of the DTA states the following:

Income from Real Property

(1) Income from real property may be taxed by the Contracting State in which such real property is situated.

(2) For the purposes of this Convention:

(i) a leasehold interest in land, whether or not improved, shall be regarded as real property situated where the land to which the interest relates is situated; and

(ii) rights to exploit or to explore for natural resources shall be regarded as real property situated where the natural resources are situated or sought.

The US and Australia taxes their residents on a worldwide basis and hence the reason why Article 6 is heavily relied upon by US and Australian residents with foreign rental properties.

In the context of Article 6, it is important to understand what constitutes real property, also referred to as immovable property, in other treaties.

The definition of real property is determined under the law of the country in which the property in question is located. Regardless of source country law, however, the concept of real property includes the following elements:

Property accessory to real property (immovable property);
Livestock and equipment used in agriculture and forestry;
Rights to which the provisions of general law respecting landed property apply;
Usufruct of real property (immovable property); and
Rights to variable or fixed payments as consideration for the working of, or the right to work, mineral deposits, sources, and other natural resources.

Ships and aircraft, however, are not regarded as real property (immovable property).

When relying on a specific provision in a DTA to determine the allocation of the taxing rights between the two countries, one of the most important distinctions to understand is the following –

‘income that may be taxed by a contracting state’ and;
‘income shall only be taxable by a contracting state’.

We are the only multi-disciplinary international CPA firm in the United States that specializes in U.S.– Australia taxation.

Article 6(1) uses the wording may be taxed and therefore does not confer an exclusive right of taxation on the State where the property is located. It simply provides that the situs State (the country where the property is situated) has the primary right to tax such income, regardless of whether the income is derived through a permanent establishment in that State or not. The country where the income producing real property is situated, is obliged to allow a resident of the other country to elect to compute that income on a net basis as if the income were business profits attributable to a permanent establishment in the source country. This is permitted in terms of IRC §871(d) and §882(d) as well in the absence of any treaty provision.

Article 6(2) incorporates the rule that a leasehold interest in land and rights to exploit or explore for natural resources constitute real property situated where the land or resources, respectively, are situated. Except for those cases, the definition of real property is governed by the internal law of the country where the property is situated.

CONCLUSION

Even though Article 6 is quite straight forward, there are various other domestic nuances to take into account when calculating your foreign rental income for either US or Australian tax purposes.

Our team of International Tax specialists at Asena Advisors, will be able to assist you with applying Article 6 correctly and how to implement same in your US or Australian tax returns.

US-AU DTA: Article 5 – Permanent Establishment

Posted on November 10, 2021November 19, 2022 by Peter Harper

GENERAL BACKGROUND

In the unprecedented COVID-19 environment the temporary displacement of employees has given rise to many concerns from employers that it may unintentionally be creating ‘permanent establishment’ issues for them in foreign jurisdictions. This is especially relevant where employees are working through the pandemic in a different country to where they ordinarily work.

Due to COVID-19, it is common for employees of US employers to be temporarily working in Australia when they would ordinarily work in the US and vice versa.

Tax authorities around the world are also targeting in particular ‘artificial PE avoidance’ by multinationals on foreign-sourced income.

This blog will highlight some of the key permanent establishment issues facing US and Australian taxpayers with an emphasis on Article 5 of the US/Australia DTA.

INTRODUCTION

The fundamental rationale behind the PE concept is to allow, within certain limits, the taxation of non-resident enterprises in respect of their activities in the source jurisdiction.

Understanding the rules relating to permanent establishments (PEs) has two steps to it.

The first step is to understand when a PE exists, and
The second step is to look at how profits are attributed to that PE.

Broadly speaking, an overseas resident has a substantive presence in a state if he meets the

threshold of having a PE. At the same time, if that person is carrying on business through the PE then tax may be due in the state in which the PE is established as well as in the state of residence.

Therefore, on its own, without a business activity through it, a PE may not of itself

give rise to a tax liability.

In its simplest form a PE exists where a company is resident in one country (referred to as the head office) but also has a business conducted from a fixed base in another country (the branch). The income attributable to the other fixed base usually attracts a tax liability in the second country.

In its more complex form of deemed PE, it is a tax “fiction” enabling tax authorities to impose corporate taxes on the deemed branch. A third type of PE is again a tax “fiction” where there is a deemed branch providing services.

INTERPRETING ARTICLE 5 OF THE DTA – PERMANENT ESTABLISHMENT

Under the US/Australia PE provision, the business profits of a resident of one treaty country are exempt from taxation by the other treaty country unless those profits are attributable to a permanent establishment located within the host country.

Article 7 of the US/Aus DTA (which will be discussed in detail in the following weeks) states that profits are taxable only in the Contracting State where the enterprise is situated “unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein,” in which case the other Contracting State may tax the business profits “but only so much of them as [are] attributable to the permanent establishment.”

TYPES OF PERMANENT ESTABLISHMENTS

There are a few common types of permanent establishment to be aware of based on traditional approaches, although these are being modified as more business is conducted virtually over digital mediums.

Fixed Place of Business Permanent Establishment

The historical and easiest test of ‘permanent establishment’ is having a fixed place of business and can include:

- A branch
- An office
- A factory
- A workshop
- A mine, or gas/oil well

Sales Agents

Employees that work as sales agents and have the authority to conclude contracts in the name of an enterprise may also be sufficient to create PE. The determining requirement is that the authority must be exercised habitually, rather than once or twice. Also, the majority of the negotiation, drafting and signing of contracts must have occurred in the host country.

Service Permanent Establishment

The areas of service PE are expanding in scope and can include situations such as providing technical or managerial services in the country.

PRACTICAL EXAMPLES OF PERMANENT ESTABLISHMENT

Building and Construction Projects

Since building and construction projects are not “permanent” for the company, the test for PE becomes more time-based. The time period applicable to the US/Aus DTA is a site which exists for at least 9 months may trigger PE.

Services and Consulting Projects

The analysis for services PE will revolve around the non-physical elements of permanent establishment, since there may be no office or branch in the country.

TYPES OF AGENCY PERMANENT ESTABLISHMENT

If a company uses sales agents inside a country, this type of activity may trigger permanent establishment if the agents are concluding contracts on behalf of the company. This qualifies for the ‘revenue creation’ element of PE, and those contracts would be subject to corporate tax if the activity is habitual and ongoing.

Digital Sales and e-Commerce

An emerging area of PE is that of revenue created through the digital economy. This is extremely prevalent, especially with online platforms being used to sell goods or services worldwide.

WHAT IS THE TAX RISK RELATED TO CREATING A PE?

When embarking on global expansion, one of the core considerations is corporate taxation on foreign sourced revenue. While a company will typically be taxed on profits in its home country, there may be additional taxes owed in other countries of business activity. This could affect the net profitability of entering a new country and should be part of an overall planning analysis.

Asena Advisors is the only multi-disciplinary (Accounting and Legal) international CPA firm in the United States that specializes in U.S. -Australia taxation.

HOW WILL A PE BE TAXED?

If sufficient presence is created in a foreign country, but a multinational, this could make it liable for local corporate taxes or value-added tax (VAT). This law basically reflects the rights of countries to tax businesses that are generating revenue through local operations, even if they maintain their principal headquarters in the home country.

The reason this becomes important for planning purposes is that a company could be subject to ‘double taxation’ on profits, since the home country could tax those amounts as well.

The IRS will impose corporate tax on foreign companies that meet the PE criteria. To avoid any penalties or back payments, a company should file IRS Form 8833 as a proactive claim on any treaty benefits with the US.

CONCLUSION

To assist in managing PE issues from a US and Australian income tax perspective, taxpayers should ensure they action the following:

Carefully monitor and keep track of the geographical working location of employees during the COVID-19 pandemic;
Understand what constitutes a PE and a deemed PE;
Seek tax advice if due to COVID-19 you have employees temporarily exercising their employment in another country;
Seek tax advice if your business tax model has changed due to COVID-19 and could potentially place you at risk of creating a PE; and
monitor and carefully consider official guidance in respect of “permanent establishment” issues (ie. from the ATO, IRS, OECD and other relevant foreign authorities);

The global pandemic has changed the way businesses conduct business. It has also created opportunities for new businesses to conduct business exclusively on online platforms, without physically being present in the country the services are provided or goods are sold.

Our team of International Tax specialists at Asena Advisor, have an in-depth knowledge of how to interpret international tax treaties and how to ensure you mitigate any potential PE risks associated with your business.

US-AU DTA: Article 4 – Residence

Posted on October 27, 2021November 19, 2022 by Peter Harper

GENERAL BACKGROUND

In this week’s blog, we will be discussing Article 4 of the DTA (Residence), with a specific focus on its applicability to individuals.

A person’s residence for treaty purposes is a key consideration when applying the DTA. Not only because this allows a person to claim certain treaty benefits, but also because the treaty will allocate taxing rights to the state of residence or the state of source. It is therefore vital to know where a person is resident for such purposes.

INTRODUCTION

Article 4 contains ‘residency tie-breakers’ to determine residence for both individuals and companies.

When the domestic law of the US and Australia result in claimed residency by both countries, the taxpayer must apply the treaty’s residency tie-breaker provisions. The reason it is important is because residency determines the taxation of many important types of income, such as dividends, interest, royalties, capital gain, pension distributions, retirement pay, annuities, and alimony.

It should be noted that these tiebreakers, for companies and individuals, apply for the purposes of the treaty and so determine a sole state as the place of residence for treaty purposes only. A person does not cease to be resident of either state for domestic law purposes unless the domestic law specifically states this.

For instance, in South Africa, the definition of ‘resident’ in Article 1 of the Income Tax Act No. 58 of 1962 includes a provision whereby the definition of ‘residence’ contained in any DTA between South Africa and another country overrides the domestic definition of a resident. So, this is an example whereby a person will cease its residency should they be regarded as an exclusive resident of another contracting states. Herewith an extract of the provision –

‘But does not include any person who is deemed to be exclusively a resident of another country for purposes of the application of any agreement entered into between the governments of the Republic and that other country for the avoidance of double taxation.’

This however does not apply to Article 4 of the DTA between the US and Australia. One should therefore be careful when applying Article 4 and what limitations apply to the specific DTA’s definition of residence.

INTERPRETING ARTICLE 4 OF THE DTA – RESIDENCE

The country of residence generally gets the most exclusive taxing rights. When an individual is determined to be a tax resident under the domestic law of two countries that have an income tax treaty with one another, there are a set of factors that ‘break the tie’. When interpreting the specific terms as set out below, one should look at the domestic interpretation of the US/Australia respectively and at the OECD commentary on Article 4 of the Model Tax Convention.

The country of residency for purposes of the DTA is determined by applying the following tie-breaker clauses in the US-Australia DTA.

Tie-breaker 1:

Permanent home – first, the country in which the individual maintains a permanent home. If the individual has a permanent home in only one of the Contracting States, the individual will be treated as a resident of that State for treaty purposes.

The IRS states that a permanent home is one that is retained for permanent and continuous use and is not a place retained for a short duration. An individual has a permanent home in the US if he or she purchased a home in the United States, intended to reside in that home for an indefinite time, and did reside in that home. Individuals may also have a permanent home where:

1. a room/apartment is continuously available to them,
2. their personal property (e.g., automobiles, personal belongings) is stored at a dwelling, and
3. they conduct business (e.g., maintaining an office, registering a telephone), including using such addresses for insurance and a driver’s license.

The OECD describes a permanent home to be a home that the:

‘Individual has arranged to have the dwelling available to him at all times continuously and not occasionally’.

We are the only multi-disciplinary international CPA firm in the United States that specializes in U.S.– Australia taxation.

Tie-breaker 2:

Habitual abode – second, if the individual’s permanent home cannot be determined, then the state in which he has a habitual abode.

The IRS states the following in this regard:

“An individual’s habitual abode is located in the Contracting State in which the individual has a greater presence during a calendar year. Although the length of time is not specified, the comparison must cover sufficient length of time and take into account the intervals at which the stays take place for it to be possible to determine where residence is habitual. For example, an individual who is present in the United States more frequently and at longer intervals than in the other Contracting State during a calendar year likely has a habitual abode in the United States. Determine whether the individual has a habitual abode in the United States by calculating how much time the individual spent in in the United States in a tax year…”

The OECD explains that a habitual abode refers to the frequency, duration and regularity of stays that are part of the settled routine of an individual’s life and is therefore more than transient.

There is no specific commentary on the Australian interpretation of the words habitual abode in the context of the Treaty, only the words habitual place of abode in the context of the statutory definition of resident in section 6 ITAA 1936. However, the Courts consider the Commentary on the OECD Model Tax Convention as authoritative guidance on the interpretation of Tax Treaties.

Tie-breaker 3:

Closer connections – third, if the individual has a habitual abode in both countries or in neither, then the country in which the individual has closer economic or personal relations, with regard being given to the country of citizenship.

The IRS considers the following factors in this regard:

Personal relations:

1. Family location – Includes parents and siblings, and where the individual spent his or her childhood.
2. Recent relocation – Whether the family moved from their permanent home to join the individual, or the individual relocated to a second state (for example, as a result of marriage).

Community relations:

Determine where the individual has his or her:

1. health insurance,
2. medical and dental professionals,
3. driver’s license/motor vehicle registration,
4. health club membership,
5. political and cultural activities, and
6. ownership of bank accounts.

Economic relations:

Determine where the individual:

1. keeps his or her investments or conducts business,
2. incorporated his or her business, and retains professional advisors (e.g., attorneys, agents, and The center of vital interests can shift, when an individual retains ties in one State but establishes ties in a second State, and all surrounding facts and circumstances must be considered in determining the individual’s center of vital interests. For example, the IRS states that evidence that an individual has executed contracts relating to his or her business in the second State may indicate that the center of vital interests is in the second State.

CONCLUSION

It is of utmost importance to ensure that you understand how to apply the tie-breaker provisions set out in Article 4(2) of the US/Australia DTA. Secondly, it is important to note that by being regarded as a resident in terms of the DTA, does not automatically cease your tax residency. Especially if you are a US citizen living in Australia. It should only be applied for purposes of the treaty and allocating the taxing rights accordingly.

Our team of International Tax specialists at Asena Advisor, have an in-depth knowledge of how to interpret international tax treaties and how to correctly apply the tie-breaker provisions.