Question

2. Cholati is a foreign corporation that produces fine chocolates for sale worldwide. Cholati markets it chocolates in the United States through a U.S. limited liability company that is treated as a disregarded entity for U.S. tax purposes. The hybrid branch operates a sales office located in New York City. During the current year, Cholati’s effectively connected earnings and profits are $3 million, and its U.S. net equity is $6 million at the beginning of the year, and $4 million at the end of the year. In addition, a review of Cholati’s interest expense account indicates that it paid $440,000 of portfolio interest to an unrelated foreign corporation, $200,000 of interest to a foreign corporation which owns 15% of the combined voting power of Cholati’s stock and $160,000 of interest to a domestic corporation. Assume that Cholati does not reside in a treaty country.

a) Compute Cholati’s branch profits tax, and then complete Section III, Part I, Form 1120-F, page 5, lines 3-6.

b) Determine Cholati’s branch interest withholding tax obligations.

Answer 1

a) Cholati’s branch profits tax will be $15,00,000. Full computation is as below :-

3	Effectively connected earnings and profits. Combine line 1 and line 2	$30,00,000
4a	Enter U.S. net equity at the end of the current tax year. (Attach required statement.)	$40,00,000
b	Enter U.S. net equity at the end of the prior tax year. (Attach required statement.)	$60,00,000
c	Increase in U.S. net equity. If line 4a is greater than or equal to line 4b, subtract line 4b from line 4a. Enter the result here and skip to line 4e
d	Decrease in U.S. net equity. If line 4b is greater than line 4a, subtract line 4a from line 4b	$20,00,000
e	Non-previously taxed accumulated effectively connected earnings and profits. Enter excess, if any, of effectively connected earnings and profits for preceding tax years beginning after 1986 over any dividend equivalent amounts for those tax years
5	Dividend equivalent amount. Subtract line 4c from line 3. If zero or less, enter -0-. If no amount is entered on line 4c, add the lesser of line 4d or line 4e to line 3 and enter the total here	$50,00,000
6	Branch profits tax. Multiply line 5 by 30% (0.30) (or lower treaty rate if the corporation is a qualified resident or otherwise qualifies for treaty benefits). (See instructions.) Enter here and include on line 3, page 1. Also complete item W on page 2	$15,00,000

b) Branch interest is the interest paid by a branch’s U.S. trade or business, is considered U.S. source income. Branch interest withholding tax obligation is 30% of the interest owed to a foreign person, unless the tax is reduced or eliminated by a specific treaty or Code provision which includes include tax on interest owed to a foreign person not being a related party or a banking corporation. Hence :-

1) Interest of $440,000 paid to unrelated foreign corporation will be exempt from branch interest withholding tax obligations.

2) Interest of $200,000 to a foreign corporation which owns 15% of the combined voting power of Cholati’s stock will be subject to tax @ 30% since this is a related party.

So the branch interest withholding tax obligation will be 30% of $200,000 i.e. $60,000