2017-08-04
Is it a good idea to set up a Belize IBC to sell products to U.S. customers thru Amazon FBA? Perhaps not.
Let’s assume the situation is as follows: An individual (let’s call her Jane) resides in a foreign country --- say, for example, Australia. Jane is not a U.S. citizen or a U.S. tax resident.
Jane decides she wants to sell products to U.S. customers where the products are manufactured in China and sold to the U.S. customers via Amazon FBA.
Under Fulfillment by Amazon (“FBA”), Jane stores her inventory in Amazon’s fulfillment centers/warehouses. Amazon picks, packs, ships, and provides customer service for those products.
Jane wants to minimize her taxes. She reads online that if she forms a Belize IBC, she can avoid paying tax in Australia and not have to pay any tax in the U.S. Since there is no Belize corporate tax on IBCs, it is a great deal!! No tax anywhere!!
So Jane contacts an advisor to set up a Belize IBC. The advisor informs her that an even better structure is to have the Belize IBC form a U.S. limited liability company (“LLC”) in a U.S. state such as Nevada or Wyoming. The LLC, Jane is told, will be a “disregarded entity” and will help in setting up a U.S. bank account. The U.S. LLC will get a U.S. employer identification number (“EIN”) that can be provided to the bank.
Jane hesitates. It seems a bit too good to be true. No tax anywhere? No tax in the U.S.? Jane’s advisor concedes that she will probably need to collect sales taxes for sales to customers located in U.S. states where Amazon stores her products. However, the advisor assures her that no U.S. Federal corporate income tax is due because her IBC and her U.S. LLC do not have any dependent agents in the U.S. Without dependent agents in the U.S., the advisor maintains, no U.S. Federal corporate income tax can be imposed.
Based on this advice, Janes forges ahead. She sets up the Belize IBC. Her Belize IBC sets up a Wyoming LLC. The LLC gets an EIN, opens a U.S. bank account, and starts selling products through Amazon FBA. The business blossoms. By the fourth year of operations, sales through the IBC/LLC total $10 million and profits are $1,000,000. All sales are to U.S. customers. The average value of the inventory stored with Amazon FBA during the year is approximately $800,000. The LLC has registered to collect (and actually collects) sales taxes on sales to customers in 3 states.
The cash profit of $1,000,000 is moved from the LLC’s U.S. bank account to an offshore account held by the IBC, but the IBC retains the profits of $1,000,000 and no income taxes are paid in any country.
If it turns out that the U.S. tax advice is wrong, Jane’s Belize IBC will owe some pretty hefty U.S. taxes. U.S. Federal corporate income taxes of $340,000 would be due on the $1,000,000 of profit. Code §11. In addition, a 30% U.S. Federal branch profits tax of $198,000 would be due on the after tax profits (1,000,000 – 340,000 = 660,000; 660,000 x 30% = 198,000). Code §884(a). Thus, the total U.S. Federal tax on the profit of $1,000,000 would be $538,000 (340,000 + 198,000). With a U.S. Federal tax rate of almost 54%, it is important that the U.S. tax advice be accurate.
Under U.S. domestic law, foreign corporations are subject to U.S. tax in two different circumstances. First, foreign corporations are subject to a flat 30% tax on their gross U.S.-source “fixed or determinable annual or periodic” income (“FDAP income”). Code §881(a)(1). FDAP income includes items such as dividends, interest, rents or royalties, etc. Gains on sales of personal property, such as gains on sales of inventory, are generally not considered FDAP. Treas. Reg. §1.1441-2(b)(1)(i) and (b)(2)(i). Consequently, the IBC should not be subject to the flat 30% tax on gross FDAP income.
The second circumstance in which a foreign corporation can be subject to U.S. tax is if: (1) the foreign corporation is engaged in the conduct of a trade or business in the U.S. (“ETOB”) and (2) the income is “effectively connected with the conduct of” that U.S. trade or business. Code §882. We first discuss whether the income would be effectively connected income if the foreign corporation were to be ETOB.
Non-FDAP income from U.S. sources is treated as effectively connected with a U.S. trade or business. Code §864(c)(3). Gains on sales of inventory (where the seller of the inventory has not itself manufactured the product being sold) is sourced 100% to the location of where title transfers. Treas. Reg. §1.861-7(a) and (c).
Since the IBC’s sales to the U.S. customers will occur at the time that the products are held in Amazon’s U.S. warehouse, the shipping point will be in the U.S. In addition, since the products will be shipped to customers located in the U.S., the destination points will also be in the U.S. Under these circumstances, it would seem inescapable that title to the inventory will transfer in the U.S.
Consequently, if the Belize IBC (directly or through its disregarded LLC) is ETOB, then (1) 100% of the profit from its sales to U.S. customers would be U.S.-source income, (2) 100% of this profit would be effectively connected with the conduct of the U.S. trade or business, and (3) 100% of this profit would be taxed in the U.S. This puts a lot of pressure on the issue of whether the Belize IBC is ETOB. If it is ETOB, all of the profits from sales to U.S. customers will be subject to a U.S. Federal tax at a rate of nearly 54%. If the IBC is not ETOB, none of the profits from sales to U.S. customers will be subject to U.S. Federal tax.
Neither the statute nor the regulations define when a foreign corporation is ETOB. Code §864(b) provides that the term “trade or business within the United States” includes the performance of personal services in the U.S.
Courts have generally held that foreign persons are ETOB if they have “considerable, continuous, and regular” business activities in the U.S. Pinchot v. Commr., 113 F.2d 718 (2d Cir. 1940), Lewenhaupt v. Commr., 20 T.C. 151 (1953), and De Amodio v. Commr., 34 T.C. 894 (1960). In Spermacet Whaling & Shipping Co. S/A v. Commr., 30 T.C. 618 (1958), the Tax Court addressed whether a foreign corporation, was “engaged in trade or business within the United States.” In interpreting the statute, the Court stated:
We have consistently held that before a taxpayer can be found to be “engaged in trade or business within the United States” it must, during some substantial portion of the taxable year have been regularly and continuously transacting a substantial portion of its ordinary business in this country. * * *
In Scottish Am. Inv. Co. v. Commr., 12 T.C. 49 (1949), the Tax Court made “a quantitative and a qualitative analysis” to determine if the foreign corporation was ETOB.
Unfortunately, the standard the courts have adopted is vague. However, as described above, whether full U.S. tax or no U.S. tax will be imposed is riding solely on the issue of whether the Belize IBC is ETOB. Clearly, the Belize IBC has some significant activities in the U.S. (directly or through the U.S. disregarded LLC). These activities include:
Is the making of $10 million of sales to U.S. customers, having sales solely to U.S. customers, and averaging $800,000 of inventory in the U.S. considerable, continuous, and regular activity in the U.S.? From a quantitative perspective, it would seem that $10 million in sales and $800,000 in inventory are quite large. From a qualitative perspective: (1) 100% of the Belize IBC’s sales were to U.S. customers, (2) 100% of its inventory was located in the U.S., (3) the Belize IBC arguably has no activity in Belize, and (4) the Belize IBC is presumably not claiming that is has any activity in Australia. From a qualitative perspective, it seems like the Belize IBC has a large portion of its business activities in the U.S.
While the standard is vague, there would certainly seem to be a very large risk that the Belize IBC would in fact be considered ETOB.
But wait! The U.S. advisor had assured Jane that no U.S. corporate income tax would be due as long as her IBC and her U.S. LLC did not have any dependent agents in the U.S. Unfortunately, there is no such rule. It is unclear where the confusion lies.
There is a rule regarding dependent agents in most U.S. income tax treaties. See Article 5 of the Model U.S. Income Tax Treaty and Article 5 of the OECD Model Income Tax Treaty. However, there is no income tax treaty between the U.S. and Belize.
There is also a rule regarding dependent agents in Treas. Reg. §1.864-7. This regulation defines whether the foreign corporation is treated as having a U.S. office for purposes of determining whether certain foreign source income is considered effectively connected income. The first sentence of Treas. Reg. §1.864-7(a)(1) provides in part:
This section applies for purposes of determining whether * * * a foreign corporation that is engaged in a trade or business in the United States at some time during a taxable year * * * has an office or other fixed place of business in the United States * * *. [Emphasis added]
The foreign corporation must already be ETOB in order for the regulation to apply. The regulation does not determine whether the foreign corporation is ETOB. Further, as described above, all of the IBC’s income would be U.S.-source income, and therefore this regulation would not be applicable.
In De Amodio v. Commr., 34 T.C. 894 (1960), the Tax Court held that a nonresident alien was engaged in a trade or business in the U.S. when the nonresident alien acquired real property through a real estate agent and managed the properties through other local real estate agents. The Tax Court concluded that the nonresident alien’s conduct of considerable, continuous, and regular activities “through his agents in the United States” caused the nonresident alien to be ETOB. The Tax Court held that the nonresident alien’s agents were independent agents.
It is unclear why some advisors continue to assert that a foreign corporation must have dependent agents in the U.S. in order to be ETOB.
No. This analysis does not only apply to Belize companies. The analysis applies to any company formed in a country that does not have an income tax treaty with the U.S. For example, companies in Hong Kong, Singapore, or Dubai would have the same issues as a Belize company.
If Jane had formed an Australian company and had operated her business through the Australian company, she may have been able to avoid U.S. tax entirely. In general, the business profits of an Australian company that qualifies for benefits under the Australia-U.S. Income Tax Treaty would be exempt from U.S. tax unless the company had a permanent establishment in the U.S. See Articles 5 and 7 of the Australia-U.S. Income Tax Treaty.