International Finance and Accounting Handbook

copyrights, to the extent that the gains are contingent on the productivity, use,

or disposition of the property sold and thus economically similar to royalties

Certain income is exempt from this 30% gross receipts tax in order to encourage
foreign investment in the United States. The exempt income includes interest on bank
deposits if the interest is not attributable to a U.S. trade or business. Another similar
exemption is interest that qualifies as “portfolio interest.” This is certain targeted bonds
that are sold only to foreign investors and that cannot be owned by U.S. corporations,
citizens, or residents. In addition, the interest cannot be received from a corporation or
a partnership in which the recipient has a 10% or greater interest and cannot be re-
ceived by a bank. This portfolio interest exception is designed to cover Eurodollar
bonds sold to the public outside the United States and eliminates the need for utiliza-
tion of expensive structures that typically have included utilizing finance companies
organized in the Netherlands or Netherlands Antilles. At present, if a foreign corpora-
tion has a U.S. subsidiary and it sells the shares of the U.S. subsidiary, the gain is not
subject to U.S. taxation unless the subsidiary constitutes a “U.S. real property interest.”
In many cases, this 30% gross receipts tax is reduced to a lower rate or completely
exempted by an income tax treaty between the United States and the country of res-
idence of the foreign investor.

(ii) Business Income. Business income that is effectively connected with the con-
duct of a U.S. trade or business is taxed at the normal U.S. rates. The income attrib-
utable to U.S. trade or business is income that is effectively connected with the con-
duct of a U.S. trade or business and sometimes referred to as “ECI (effectively
connected income).” Deductions are allowed to the extent they relate to the ECI.
Complex regulations are used to determine when expenses of a foreign corporation
are attributable to ECI.

(b) U.S. Trade or Business

(i) Definition. In order for a foreign corporation to be engaged in a U.S. trade or
business, there must be a significant amount of business activity in the United States.
The term trade or businessis not defined in the tax law but is based upon specific
facts and circumstances of the taxpayer. Foreign investors, other than dealers, can
trade in stocks, securities, and commodities in the United States without being en-
gaged in a trade or business in the United States.

(ii) Effectively Connected Concept. A foreign corporation that is engaged in trade or
business within the United States is taxed at the regular corporate rate on income that
is “effectively connected” with the conduct of that trade or business. This effectively
connected concept applies to four types of income:

1.Gain or loss from the sale or exchange of capital assets

2.Fixed or determinable annual or periodic income

3.Gain or loss in the disposition of U.S. real property interest

4.All other income, gain, or loss

All income from U.S. real property interest is automatically considered ECI. U.S.

30.7 U.S. TAXATION OF A FOREIGN CORPORATION 30 • 19