One is, in fact, at the mercy of the Service in the event of an audit of delinquently filed returns. A related area of concern involves foreign corporate activity, where returns may be required if business is conducted in the U.S., even to a limited extent. In general, if income is earned in the U.S. or from a U.S. trade or business, a return must be filed. In many instances, an income tax treaty may exist between the U.S. and the country of incorporation. The existence of a PE means that a level of U.S. activity or presence is enough to subject the company's income to federal tax.
Many foreign businesses qualify for exemption from federal taxation under treaty exclusions.
However, unless a tax return is filed and the exemption claimed, the treaty will be disregarded and the Service can take a position similar to that in the Florez case. The importance of determining one's tax obligation and taking proper steps, as noted above, often means the difference between paying no tax and paying tax based on gross income. Interest and penalties can also be assessed. The regulations referred to above, which disallow deductions in toto, do not apply to U.S. residents, citizens, or domestic corporations, thus reflecting the increasing toughness by the Service and courts in the international arena. The comments presented herein are general in nature and consultation with your tax or financial adviser is recommended.