Source: https://www.fenwick.com/insights/publications/taxation-of-foreign-fund-lending-activities-in-the-us
Timestamp: 2020-06-04 01:12:55
Document Index: 370982462

Matched Legal Cases: ['§ 882', '§ 1', '§ 864', '§ 864', '§ 864', '§ 864', '§ 1', '§ 861', '§ 864', '§ 1', '§ 1', '§ 1', '§ 1', '§ 864', '§ 1', '§ 1', '§ 1', '§ 864', '§ 864', '§ 864', '§ 864', '§ 1', '§ 1', '§ 1', '§ 864', 'Art. 5', 'Art. 5', 'Art. 5', 'Art. 5', 'Art. 5', 'Art. 5']

Taxation of Foreign Fund Lending Activities in… | Fenwick & West LLP
A foreign fund that originates loans in the US through the origination services of an independent agent that does not have the power or the authority to bind and conclude contracts on behalf of the foreign fund may find itself having a trade or business within the US that produces income effectively connected with that business in the form of the interest received on the loans to US borrowers. That, at least, is the view of the IRS.
Whether a foreign lender has a “trade or business within the United States” (“USTB ”) is generally a question of fact that depends on the nature and extent of the foreign investor’s US-based activities.2 A clear definition of a USTB is not provided anywhere in the Internal Revenue Code. Instead, the applicable standards have been developed by case law and are highly fact-specific.3 In general, a USTB exists if the taxpayer engages in profit-oriented activities in the US that are considerable, continuous and regular.4 A single transaction or operations that are limited in scope and take place over a limited period of time, would typically not be considered considerable, continuous and regular. Furthermore, ministerial, clerical or collection-related activities are not sufficiently profit-oriented to constitute a USTB.5 Rather, the activities must be of a type that is closely and directly related to the derivation of profit.6 Thus, the existence of a USTB depends upon both the quality and the quantity of the foreign corporation’s activities within the US.
In addition, trade or business within the United States does not include trading in stocks or securities for the taxpayer’s own account, whether by the taxpayer or his employees or through a resident broker, commission agent, custodian or other independent agent, and whether or not any such employee or agent has discretionary authority to make decisions in effecting the transaction.10 °
With respect to US source interest income,12 when determining that such income is effectively connected with the conduct of a trade or business within the United States, the factors taken into account include whether (i) the income is derived from assets used in or held for use in the conduct of such trade or business (“the Assets Test ”), or (ii) the activities of such trade or business were a material factor in the realization of the income (the “Business Activities Test ").13
Nonetheless, in a 2009 Legal Advice Memorandum (the “2009 HM ”),17 the IRS concluded that a foreign lender receives taxable effectively connected US source interest income on loans generated in the United States, by an independent agent without the power or the authority to bind the foreign lender. This questionable position is discussed immediately below.
The memorandum describes a foreign lender, organized in a non-treaty country (perhaps the Cayman Islands?), that makes loans to multiple US borrowers. It has no office in the United States. It outsources the origination activities to a US corporation (“Origination Co. ”), which does have an office in the US. Origination Co. takes all steps necessary to generate the loan applications and send them to the lender abroad, including soliciting US borrowers, negotiating the terms of the loans, performing the credit analyses with respect to US borrowers, and all other activities relating to loan origination other than the final approval and signing of the loan documents. Origination Co. is not authorized to conclude contracts on behalf oldie foreign lender. The foreign lender approves (or not) the loan applications outside the US and physically signs the loan documents outside the US. Origination Co.’s activities are “considerable, continuous and regular,” and it is being compensated for its services with an arm’s length fee. However, there is no indication that Origination Co. is related to the foreign lender, performs similar services for others or is otherwise controlled by the foreign lender.
Relying,inter alia, on Inverworld, Inc. v. Commissioner, 18 the Associate Chief Counsel concluded that although Origination Co. acts on behalf of the foreign lender pursuant to a service contract and does not have authority to conclude contracts, Origination Co. performs activities that are a component of the foreign lender’s lending activities. As a result, an agency relationship exists in fact, to attribute the activities of the US agent to the foreign principal, in determining whether the foreign principal conducted considerable, continuous and regular activity within the US. Because the lending activities of the foreign lender, which were carried out by Origination Co., were considerable, continuous, and regular, the foreign lender is engaged in a USTB.
1 §§ 882(a)(1), 882(a)(1). All section (“§ ”) references are to the Internal Revenue Code of 1986, as amended (the “Code ”), and the Treasury Regulations (“Treas. Reg.”) promulgated thereunder, except where specifically indicated otherwise.
2 See Treas. Reg. § 1.864-2(e);Higgins v. Commissioner, 312 US 212, 217 (1941); Spermacet Whaling & Shipping Co. v. Commissioner, 30 TC 618, 634 (1958), aff’d, 281 F.2d 646 (6th Cir. 1960).
3 Rev. Rul. 88-3, 1988-1 C.B. 268 (“[T]he determination whether a taxpayer is engaged in a trade or business within the United States is highly factual”);Higgins, 312 US at 217 (“To determine whether the activities of a taxpayer are ‘carrying on a business’ requires an examination of the facts in each case”); Calvao v. Commissioner, 93 TCM 988 (2007) (“Whether the taxpayer is carrying on a trade or business requires an examination of all the facts in each case”).
4 De Amodio v. Commissioner, 34 TC 894, 906 (1960), aff’d, 299 F.2d 623 (3rd Cir. 1962) (finding that the taxpayer’s activities were “considerable, continuous and regular,” and therefore constituted engaging in business in the US); see alsoLewenhaupt v. Commissioner, 20 TC 151, 163 (1953),aff’d, 221 F.2d 227 (9th Cir. 1955).
6 See, e.g., Investors’ Mortgage Security Co. v. Commissioner, 4 TCM 45 (1945) (holding that the taxpayer’s “management of real estate... for income producing purposes required regular and continuous activity of the kind which is commonly concerned with the employment of labor; the purchase of materials; the making of contracts; and many other things which come within the definition” of business, and therefore constituted a USTB).
7 § 864(b).
8 § 864(b)(2)(A)(i).
9 § 864(b)(2)(C).
10 § 864(b)(2)(A)(ii). This exception does not apply in the case of a dealer in stocks or securities.
11 Treas. Reg. § 1.864-2(e).
12 The source of interest income as foreign or domestic depends upon the borrower. In general, interest income from loans made to US borrowers will be sourced as income from sources within the United States. § 861(a)(1).
13 § 864(c)(2); Treas. Reg. § 1.864-4(c)(2), (3) and (5).
14 Treas. Reg. § 1.864-4(c)(5)(ii). In addition, the securities must be acquired in one of the specified manners enumerated in the regulations, which includes making loans to the public. Treas. Reg. § 1.864-4(c)(5)(iv) provides rules for determining when a stock or security was acquired in the course of making loans to the public.
15 Treas. Reg. § 1.864- 4(c)(5)(iii).
16 § 864(c)(5)(A); Treas. Reg. § 1.864-7(d).
17 CC: INTL:BR5 - PRENO-119800-09 (September 22, 2009).
18 TC Memo. 1996-301 (finding that the activities of a US corporation, although nominally an independent contractor and not an agent, were attributed to a foreign corporation where the activities of the US corporation were in fact those of an agent.)
19 Treas. Reg. § 1.864-4(c)(5)(0).
20 Treas. Reg. § 1.864-4(c)(5)(ii).
21 Generally, under § 864(c)(4)(A), foreign source interest income is not treated as effectively connected with the conduct of a United States trade or business. Foreign source interest income of a foreign corporation derived from the active conduct of a banking, financing or similar business within the United States, however, is treated as effectively connected with the conduct of a United States trade or business “if such person has an office or other fixed place of business within the United States to which such income, gain or loss is attributable.” § 864(c)(4)(B). For purposes of § 864(c)(4)(B), when determining whether a foreign corporation has an office or other fixed place of business, the office or other fixed place of business of an agent will be disregarded unless the agent (i) has the authority to negotiate and conclude contracts in the name of the foreign corporation and regularly exercises such authority and (ii) is not a general commission agent, broker or other independent agent acting the ordinary course of business. § 864(c)(5)(A). See also Treas. Reg. § 1.864-7(d).
22 Treas. Reg. § 1.864-7(a)(1).
23 Treas. Reg. § 1.864-4(c)(5)(iii).
24 A similar view, although with very little discussion or authority to rely on, was expressed by the Associate Chief Counsel in ILM 201501013 (1/2/2015), where the IRS considered whether a fund manager that repeatedly originated loans and acted as an underwriter in various stock offerings from its US office on behalf of a family of hedge funds was engaged in a US trade or business. The fund manager negotiated directly with borrowers, conducted extensive due diligence, originated a large portfolio of loans, solicited business with borrowers and issuers, and received fees and other compensation for its services. The IRS determined that the activities imputed to the funds did not qualify as “trading in stocks or securities” under § 864(b)(2)(A)(i) for two reasons.First, because they received fees, commissions and discounted property in exchange for their lending and underwriting services, the funds were acting as dealers in stocks and securities, not traders. And second, the lending activities of the funds constituted the active conduct of a banking, financing or similar business. According to the IRS, activities undertaken on behalf of an entity by an agent can be considered to be performed by the entity itself.
25 See e.g., Standard Pressed Steel Co. v. Department of Revenue, 419 US 560 (1975), Goldberg v. Sweet, 488 US 252 (1989), and Scripto, Inc. v. Carson, 362 US 207 (1960), where courts have concluded that the state could impose use tax even though the only connection with the state was to sell inventory using independent contractors.
26 See generally, Rosenbloom, Sutherland, & Ring, “Taxation of Permanent Establishments: The United States,” in The Taxation of Permanent Establishments (IBFD 2006).
27 2006 US Model Treaty Arts. 5(5), 5(6). See also OECD Model Treaty Arts. 5(5), 5(6).
28 See, e.g., Rev. Rul. 55-617, 1955-2 C.B. 794 (corporation doing extensive business in the United States through the medium of an independent commission agent has no US PE).
29 OECD Commentary, 1992 and 2005, Art. 5, 37. See also Taisei Fire and Marine Insurance Co. v. Commissioner, 104 TC at 549-51.
30 OECD Commentary, 1992 and 2005, Art. 5, 38.
31 See generally Taisei Fire and Marine Insurance Co. v. Commissioner, 104 TC 535 (1995), acq., 1995-2 CB 1. Despite the attempts in Taisei and the OECD Commentary to distinguish “legal” and “economic” independence, the two concepts overlap to a significant extent. The Technical Explanation lists a number of factors that are relevant to the overall determination of agency independence. These factors are substantially similar to the criteria set forth in the OECD Commentary for determining legal and economic independence. See US Model Treaty Technical Explanation, 2006, Art. 5, 6.
32 2006 and 2016 US Model Treaty Art. 5(5); OECD Model Treaty Art. 5(5).
33 OECD Commentary, 2005, Art. 5, 32.
34 Even a dependent agent who has and habitually exercises the authority to conclude contracts binding the principal, however, will not constitute a PE if the agent’s activities are limited to activities of a preparatory or auxiliary nature, as defined in Article 5 of the 2006 and 2016 US and OECD Model Treaties.