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If a Offshore Corporation does trading in stocks and bonds

I am a US Citizen...

I am a US Citizen.  If I own an Offshore Corporation and it does trading in stocks and bonds through a US Brokerage, and the trader (myself) is domiciled in the US, are the profits taxable as US income if the profits are not repatriated back to the US?

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Answered in 22 minutes by:
9/4/2012
USTaxAdvising
Category: Tax
Satisfied Customers: 1,237
Experience: US Taxation specialist.
Verified

USTaxAdvising :

Hi

Customer:

Hi


 

USTaxAdvising :

There are 2 pieces to your question. The first is that you being domiciled in the US does not give rise to ECI (Effectively Connected Income) for the Offshore corporation as you are trading for your own account. Thus the "trading for your own account" exception kicks in under IRC 864(b)(2)

USTaxAdvising :

The next piece is that you are a U.S. citizen and presumably own greater than 50% of the voting stock of the offshore corporation. Thus the offshore corporation would be considered a CFC (Controlled foreign corporation)

Customer:

Is it taxable as US Income?


 

USTaxAdvising :

If the majority of the income of the CFC is from your trading activities then the subpart F rules would apply, specificly IRC 954(c), and require you to include in your income the passive income of the CFC whether or not distributed.

USTaxAdvising :

So yes, the income would be taxable in the U.S. regardless of whether or not the CFC pays out cash.


 

Customer:

What do u mean -- passive? I am saying if I am the trader -- that means active.


 


 

USTaxAdvising :

Passive meaning that the income is interest, dividends, capital gains, FX, etc.


 

USTaxAdvising :

Portfolio income is probably a better word

Customer:

Back to my original question --- I am trading. Will the profits be taxed as US income?


 

USTaxAdvising :

Note that Subpart F would only apply so long as there is "profits", it will not apply when there are losses.

USTaxAdvising :

Will the profits be taxed as US income? - Yes

Customer:

Apple, Cisco, Google etc... have set up foreign corporations and subsidiaries in foreign domiciles and pay very low US taxes. If what u r saying is true, how do they avoid US taxes?


 

USTaxAdvising :

They don't. They might be able to defer the recognition of the income through the use of offshore companies but they won't avoid the tax.

USTaxAdvising :

It's coming at some point. Or they might be able to change the character of income to a more favorable rate.

Customer:

How do they defer the income? How do I accomplish the same thing?

USTaxAdvising :

If they owned less than 50% of a foreign corporation it would not be considered a CFC. But if it generated more than 75% of portfolio income and held 50% of passive assets (cash and cash equivalents) then corporation would be classified as a PFIC (Passive foreign investment company)

USTaxAdvising :

You could accomplish the same thing if you did not own more than 50% of the offshore corporation.

USTaxAdvising :

Your best bet is to keep the trading of your business inside the U.S.

USTaxAdvising :

People use hedge funds and private equity funds for offshore vehicles when there are multiple investors. Not for a single person.

Customer:

Apple clearly does not own less than 50% of the foreign corporations that collect their revenues. For example, their subsidiary in Ireland report all their EU income. How do they accomplish that?


 

Customer:

Besides, what if I own a US corporation that owns 48% of that foreign corporation, and my son owns 26% and another owns 26%, does not not solve the problem?

USTaxAdvising :

The business is active and is not trading in stocks and securities. They sell products and that's the difference. If they were trading for their own account with a CFC the same rules would apply to them.

Customer:

Is trading not active?

USTaxAdvising :

Besides, what if I own a US corporation that owns 48% of that foreign corporation, and my son owns 26% and another owns 26%, does not not solve the problem? - hahahaha. Sorry, someone else has thought of that many years ago. So the IRS has implemented a rule called constructive ownership. So when you look to see when a company is a CFC you have to include your shares and all your family members/relatives.


USTaxAdvising :

Is trading not active? - not within the meaning of IRC 954(c).


Customer:

OK, not my son then ..... 2 friends


 

USTaxAdvising :

OK we are getting off the question at hand.

USTaxAdvising :

OK, not my son then ..... 2 friends - if any U.S. person has greater than 10% voting stock they are counted towards the CFC definition.


 


USTaxAdvising :

Plus if it's not a CFC it would be a PFIC and that would be even less desirable.

USTaxAdvising :

Trust me. If you want to minimize your taxes as a trader keep your operations in the U.S.

USTaxAdvising :

I have been working with traders, hedge funds, and PE funds for the better part of three years and I know what I am talking about.

Customer:

These are relevant questions to my original question. If I were to pay another pmt for answering it, I'd be happy to do so. Romney used Bain Capital to do it legally. I want to do the same thing. I have a US Nevada based corporation which I can use to do the same thing as Bain Capital.

USTaxAdvising :

back to your question - are the profits taxable as US income if the profits are not repatriated back to the US? - yes, under IRC 954(c) or IRC 1291-1297.

USTaxAdvising :

Romney used Bain Capital to do it legally. I want to do the same thing. I have a US Nevada based corporation which I can use to do the same thing as Bain Capital. - OK let's walk through the steps. You put funds in an offshore corporation and it trades in the U.S. for it's own account. This by itself does not give rise to taxable income in the U.S. (IRC 864) But if the offshore corporation does not do anything else but trade for it's own account IRC 954 and IRC 1291-1197 kick in and require you to include in your taxable income for the year the "profits" of the foreign corporation whether or not the cash is distributed.

USTaxAdvising :

Hedge Funds do much the same thing and many are in fact located in the U.S. such as Delaware and NY. The main downside in the U.S. is the state level taxation. But if you are in a tax free state then you have nothing to worry about.

USTaxAdvising :

Hedge Funds like Bain Capital are using offshore partnerships to hold investors funds because they can attract people from all over the globe. If the funds are based in the U.S. many foreign investors are less likely to invest as they fear U.S. taxation on thier investment. A tax free domicile like the Cayman Islands (where I am writing you from right now) provides such a location.

Customer:

If my question fall outside my original question, I am very willing to pay extra for your advise.


 


But if you are in a tax free state then you have nothing to worry about. -- My corporation is in Nevada


 


But if the offshore corporation does not do anything else but trade for it's own account IRC 954 and IRC 1291-1197 kick in and require you to include in your taxable income for the year the "profits" of the foreign corporation whether or not the cash is distributed. -- How does Romney do it through Bain then? I understand Bain is just a trading company.

USTaxAdvising :

How does Romney do it through Bain then? - they don't use a foreign corporation they are using a foreign partnership.

USTaxAdvising :

And all the character of income and gain flows right through to the partners.

USTaxAdvising :

Bain capital is not saving money on U.S. tax for their investors. (quite the contrary actually) They probably have U.S. partnerships which invest in the Master offshore fund.

Customer:

Romney is still the majority holder of Bain --- probably a partner with controlling interest.


 


i dont know about his "investors", but Romney himself still pays a very low tax rate through use of Grand Cayman. Are u saying he does that through hedge fund style tax loopholes as opposed to using tax havens?


 

USTaxAdvising :

I am going to step away for a minute or two. If you have any questions please post and I'll revert asap. I hope this makes sense. My apologies if I come off rash it's just that there is a huge misconception by people that putting their money offshore will avoid tax. This is true if you do not declare it and follow the rules. If you follow the rules it is best to keep the money in the U.S.

USTaxAdvising :

Romney is still the majority holder of Bain --- probably a partner with controlling interest. - probably yes, but Bain is the management company and is most likely not an investor in any of the funds it manages.


 


Are u saying he does that through hedge fund style tax loopholes as opposed to using tax havens? - No, there are no hedge fund style tax loop holes.

Customer:

Thank you for your patience. I fully intend not to break any laws. But how does Romney manage to pay at such a low tax rate when his income is ---- 44 M or something?


 

Customer:

I am not interested on how it is not possible. If Romney can do it legally, and I am sure he is, I am interested on how it can be done.

USTaxAdvising :

But how does Romney manage to pay at such a low tax rate when his income is ---- 44 M or something? - His management company is most likely a partnership and it receives "preferred returns" and performance fees from the hedge and PE funds. As such the character of income stays the same from those funds. (i.e long term capital gains and qualified dividends - which are currently taxed at 15%) Thus when he receives the income at the individual level it is as if he earned it directly from the hedge fund. He also isn't paying self employment tax which is 13.2% (approx.)

USTaxAdvising :

As a trader you probably don't get much long term capital gains or qualified dividends otherwise you would be classified as an investor and not have trader status. Thus all your income is most likely taxed at 35%. Unlike Mr. Romney who probably is getting close to 15%.

USTaxAdvising :

This make better sense?

USTaxAdvising :

If you want to do the same thing as Bain you need to invest for the long term and invest in corporations that provide qualified dividends.

Customer:

U r doing a great job. But I am old and getting dense. Please excuse my ignorance.


 


What is a PE fund?


 

USTaxAdvising :

Private Equity - these investment funds invest in non public undervalued companies and try and turn them around to get a higher valuation and take them public for a big score. Some win and some fail.

Customer:

I am familiar with Private Equity firms -- I have a couple of friends that head that king of thing. I just didnt make that connection.


However, I read somewhere that Bain does Trading --- that they benefit whether the companies win or lose --- like with Trading Calls and Puts --- something that I also do.


 

Customer:

Besides, if he earns fees from the funds, and they are taxes at a LT cap gains rate instead of being taxed as ordinary income, isnt that a hedge fund manager loophole?


 

USTaxAdvising
Category: Tax
Satisfied Customers: 1,237
Experience: US Taxation specialist.
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