Question

Discussion Topic 1: Why do income source rules play a more prominent role in the taxation of foreign persons? How does the potential for United States withholding contribute to this?

Discussion Topic 2: The international tax law changes contained in the Tax Cuts and Jobs Act (TCJA) are the most sweeping since 1986. In what ways did these changes bring the United States closer to a territorial tax system than a credit system?

Answer 1

A foreign person includes a nonresident alien individual, foreign corporation, foreign partnership, foreign trust, foreign estate, and any other person that is not a U.S. person. It also includes a foreign branch of a U.S. financial institution if the foreign branch is a qualified intermediary. In most cases, the U.S. branch of a foreign corporation or partnership is treated as a foreign person.

Why do income source rules play a more prominent role in the taxation of foreign persons?

Nonresident Aliens and foreign corporations are generally subject to tax only on their U.S. source income. Income is generally U.S. source if it is produced by an activity or an investment in the United States. They determine the extent of a foreign tax credit, which is available to reduce U.S. income tax on the same items of income which have also been subject to foreign taxes.So income source rules play a prominent role in the taxation of foreign persons.

How does the potential for United States withholding contribute to this?

A payee is subject to withholding only if it is a foreign person. US Withholding tax rate is 30%. The NRA withholding tax is generally withheld from the payment made to the foreign person. Withholding increases compliance and decrease evasion or underpayment of tax. Withholding also makes it more difficult for tax protesters and tax evaders to keep their money out of the IRS's hands. It further decreases the collection costs since these taxes are remitted to the government by the employers to the IRS. Thereby IRS theoretically has a smaller pool of people to go after for unpaid or underpaid taxes. Thus even though the foreign person could move outside the legal boundaries of USA, the withholding tax makes sure that the IRS gets what it is owed.