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Lev
Lev, Tax Advisor
Category: Tax
Satisfied Customers: 22748
Experience:  Taxes, Immigration, Labor Relations
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Hi were Chinese Nationals looking to invest in the US Real

Customer Question

Hi we're Chinese Nationals looking to invest in the US Real Estate Market. We want to open up a financing LLC in China and a Real Estate LLC in the US. So the Financing LLC will be loaning all the investment money to the Real Estate LLC. All the loans will be made at the current market rate. Here are the questions we have:
1. Can the Financing LLC be owned by the same person as the Real Estate LLC? If no how would we proceed?
2. Will the IRS allow interest expense deduction for the Real Estate LLC? If no please explain in detail why not and if there is any way to allow such deduction.
3. According to the UNITED STATES-THE PEOPLE'S REPUBLIC OF CHINA INCOME TAX CONVENTION Article 10 on Interests: Interest arising in a Contracting State(US) and paid to a resident of the other Contracting State(China) may be taxed in that other Contracting State(China). However, such interest may also be taxed in the contracting State(US) in which it arises and according to the laws of that Contracting State(US), but if the recipient is the beneficial owner of the interest, the tax so charged shall not exceed 10 percent of the gross amount of the interest. So does that mean interest income for the Financing LLC can be taxed under Chinese law and if the owner of that LLC choose to receive payment in the US it can only be taxed at most 10% of interest?
Submitted: 10 months ago.
Category: Tax
Expert:  Lev replied 10 months ago.

Lev :

Hi and welcome to our site!
1. Can the Financing LLC be owned by the same person as the Real Estate LLC? If no how would we proceed?
Yes - that is possible - both LLCs will be treated as partnerships - and are separate entities.

2. Will the IRS allow interest expense deduction for the Real Estate LLC? If no please explain in detail why not and if there is any way to allow such deduction.
Yes - deduction is allowed. However - the interest income will be taxable for the Financing LLC as income from US sources.

Lev :

3. According to the UNITED STATES-THE PEOPLE'S REPUBLIC OF CHINA INCOME TAX CONVENTION Article 10 on Interests: Interest arising in a Contracting State(US) and paid to a resident of the other Contracting State(China) may be taxed in that other Contracting State(China). However, such interest may also be taxed in the contracting State(US) in which it arises and according to the laws of that Contracting State(US), but if the recipient is the beneficial owner of the interest, the tax so charged shall not exceed 10 percent of the gross amount of the interest. So does that mean interest income for the Financing LLC can be taxed under Chinese law and if the owner of that LLC choose to receive payment in the US it can only be taxed at most 10% of interest?
based on your explanation - we need to rely on the Article 6 (Income from Real Property.
Interest income on the loans to purchase real property is considered income from Real Property and as such will be taxable in the US.
See page 7 - http://www.irs.gov/pub/irs-trty/china.pdf

1. Income derived by a resident of a Contracting State from real property situated in the other Contracting State may be taxed in that other Contracting State.
The Financing LLC registered in China will be classified as a foreign entity doing business in the US - and will be taxed ONLY on income from US sources.
While you are correct - for the interest income - the factor to determine the source is the Residence of payer - not the residence of the recipient.
There are some complex rules to determine the source of income. You may take a look - page 12 IRS publication 519 - http://www.irs.gov/pub/irs-pdf/p519.pdf - Table 2-1. Summary of Source Rules for Income of Nonresident Aliens.

Expert:  Lev replied 10 months ago.
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Expert:  Lev replied 10 months ago.
Just in case you were not able to use the chat - I am switching to Q&A mode and posting the answer below.
Please feel free to communicate if you need any clarification or have other tax related issues.

1. Can the Financing LLC be owned by the same person as the Real Estate LLC? If no how would we proceed?
Yes - that is possible - both LLCs will be treated as partnerships - and are separate entities.

2. Will the IRS allow interest expense deduction for the Real Estate LLC? If no please explain in detail why not and if there is any way to allow such deduction.
Yes - deduction is allowed. However - the interest income will be taxable for the Financing LLC as income from US sources.

3. According to the UNITED STATES-THE PEOPLE'S REPUBLIC OF CHINA INCOME TAX CONVENTION Article 10 on Interests: Interest arising in a Contracting State(US) and paid to a resident of the other Contracting State(China) may be taxed in that other Contracting State(China). However, such interest may also be taxed in the contracting State(US) in which it arises and according to the laws of that Contracting State(US), but if the recipient is the beneficial owner of the interest, the tax so charged shall not exceed 10 percent of the gross amount of the interest. So does that mean interest income for the Financing LLC can be taxed under Chinese law and if the owner of that LLC choose to receive payment in the US it can only be taxed at most 10% of interest?
based on your explanation - we need to rely on the Article 6 (Income from Real Property.
Interest income on the loans to purchase real property is considered income from Real Property and as such will be taxable in the US.
See page 7 - http://www.irs.gov/pub/irs-trty/china.pdf

1. Income derived by a resident of a Contracting State from real property situated in the other Contracting State may be taxed in that other Contracting State.
The Financing LLC registered in China will be classified as a foreign entity doing business in the US - and will be taxed ONLY on income from US sources.
While you are correct - for the interest income - the factor to determine the source is the Residence of payer - not the residence of the recipient.
There are some complex rules to determine the source of income. You may take a look - page 12 IRS publication 519 - http://www.irs.gov/pub/irs-pdf/p519.pdf - Table 2-1. Summary of Source Rules for Income of Nonresident Aliens.

Expert:  Lev replied 10 months ago.
In additional...

So basically the income of the Financing LLC while registered to China is taxable in the US?
Yes - that is correct - as long as a foreign entity ( the Financing LLC registered in China) will have income form US sources.
How will it report it's interest income in the US?
Generally foreign entities are classified as corporations - and file income tax return - form 1120F OR partnership - and file income tax return - form 1065.
However in your situation - I see no reason of having two separate entities - just additional overhead.
What if China also tax the LLC does it qualify for foreign tax credit?
It is possible that an entity or a person is subject of income tax in several jurisdictions. As you know the US and China have different tax laws. However the purpose of income tax convention between these two countries is to eliminate or reduce double taxation of the same income. For instance - US residents may claim a credit for taxes paid to foreign jurisdictions. Most likely China has similar policy.
Specifically - see page 13 - http://www.irs.gov/pub/irs-trty/china.pdf - ARTICLE 22 (Elimination of Double Taxation).

Let me know if you need any help.

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