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The problem is that the UK company is not simply a withholding company. That term refers to pass through entities such as stock brokers. They receive dividend from companies, withhold necessary taxes and pass the net along to the actual stockholders.
Article 10 does provide for US taxation, in this case at the US and locality levels, and you will need to plan for this. The foreign tax credit here gives US persons/entities credit for taxes paid to other nations (UK included) so there is likely a reciprocal credit on your end of this to help avoid duplicate taxes.
Hi, I'm still unclear on this. Can you please clarify where exactly the exemption falls down.
If I own 100% of the shares of UK company which in turn owns 100% of the share capital of the US C Corporation. The US C Corporation earns profits on rental income from residential property.
If the C Corp pays dividends to the UK Co then working through Article 10 I understand as follows:
Para 1: Dividends may be taxed in the receiveing state (UK)
Para 2: Dividends may also be taxed in the paying state (US) but reduced to 5% if the beneficial owner is a resident of the other state (UK) and owns >10% of the voting power of the paying company.
Para 3 (a) (iii):Dividends shall not be taxed in the paying state (US) if the beneficial owner of the dividend (UK Co) is at least 95% owned by 7 or fewer equivalent beneficiaries, and less than 50% of the gross income of the C Corp is distributed to persons who are not equivalent beneficiaries.
Para 4: Deals with pooled investment vehicles therefore paragraph irrelevant
Paras 5 - 8: Deal with permanent establishments therefore paragraphs irrelevant
Para 9: Deals with conduit arrangements therefore paragraph irrelevant
Very close. Here is where we do not see eye to eye and it may just be word choices.
Para 2. The payment of dividends in the US (regardless of where they go) does not itself generate a tax. The profit generates a tax. The payment of dividends to a foreign (non US) resident entity generates an income tax just as it would to a US citizen. It is really not the paying but the receiving that causes the income to be taxed. However, the tax here will be only at the 5% rate due to the treaty.
Para 3. This serves to further reduce the tax rate to 0% if the conditions are satisfied.
Para 4-9. Correct.
Thanks. I think it is just our choice of words.
But are you agreeing that the tax rate would reduce to 0% under Para 3 with the ownership structure as I've described.
So overall, and including previous questions we've discussed I can summarise as follows:
Assuming the C Corporation made a $10,000 profit off $35,000 income:
I could set up a management charge from the UK Holding Co to the US C Corpoartion of 25% of revenue giving a further tax deduction of $8,750 which would leave profits chargeable to US corporation tax of $1,250.
Profits are derived entirely from the letting of residential property to private individual/families.
At this level there would be Federal Tax at 15% and Tennessee State tax of 6.5% i.e. tax of $268.75 giving profit after tax of $981.25. I don't believe there are any other applicable taxes but please correct me if I'm mistaken.
$981.25 would be avaible to distribute as a dividend, but the receipt by the UK Co would not attract any tax on the dividend. On this point would the UK Co still have to complete a Federal Tax Return and would this treaty benefit have to be agreed in advance.
The taxes you have calculated are not quite correct in their application. The TN tax is deductible on the US tax return in the year they are paid (cash basis) or the year in which they accrue (accrual basis accounting). Assuming an accrual basis taxpayer the US tax would then be reduced to 15% of $1250 or $175.31 leaving an after tax profit of $993.44. If you use cash basis the tax to the state would be deductible in the year paid rather than the year for which it is paid. This is a small difference and is deductible at one point or the other so the discussion is not a significant one.
As to the rest you are correct.A US corporation return would be required for the US corporation and the UK corporation should still file a US return showing the US income and then excluding it referencing the tax treaty.
Thanks very much your clearing this up as these aspects can get quite complex.
A final note though. In your calculation above I may be misunderstanding something or not taking something into a/c but couldn't follow through to the figures as you have them. Did you mean:
tax at 15% of $1,250 which would give tax of $187.50 and profit after tax of $1,062.50
Here is how it goes:
Income before taxes $1250
Less State tax 81.25 (accrual basis used for this illustration)
Federal taxable income 1168.75
US Tax rate x 15%
US tax 175.31
Total tax 256.56 (81.25 + 175.31)
The US tax is calculated after deducting the state tax. That is why our amounts differed. It is a procedural matter but can easily be confusing if it is not what you are accustomed to. The US tax is not deductible.
Mystery solved. Thanks very much.