By Lynn K. Ching
In general, a foreign branch for U.S. tax purposes is a division which operates a trade or business in a foreign country and maintains a separate set of books and records. The foreign branch generally is subject to the income tax laws in the foreign country in which it operates.
Under the treasury regulations, the term foreign branch means an integral business operation carried on by a U.S. person outside the United States. Whether the activities of a U.S. person outside the United States constitute a foreign branch operation must be determined under all the facts and circumstances.
Activities outside the United States shall be deemed to constitute a foreign branch for purposes of this section if the activities constitute a permanent establishment under the terms of a treaty between the United States and the country in which the activities are carried out.
Any U.S. person may be treated as having a foreign branch for purposes of this section, whether that person is a corporation, partnership, trust, estate, or individual.
Do the Activities Constitute a Permanent Establishment Under Tax Treaty?
Evidence of the existence of a foreign branch includes, but is not limited to, the existence of a separate set of books and records, and the existence of an office or other fixed place of business used by employees or officers of the U.S. person in carrying out business activities outside the United States.
While the existence of an office or physical location for the foreign location workers does bolster the argument that there is a foreign branch, the absence of the office or physical location is not by itself determinative.
Qualified Business Unit (QBU) May Also be Foreign Branch
For purposes of U.S. reporting (Form 8858 is used to report activity of all foreign disregarded entities and foreign branches), a foreign branch may also include a qualified business unit (QBU) that is foreign.
Definition of a qualified business unit— In general, a QBU is any separate and clearly identified unit of a trade or business of a taxpayer provided that separate books and records are maintained.
Under the QBU rules (Treas Reg. 1.989(a)-1(b)(2)(ii)), any activity (wherever conducted and regardless of its frequency) that produces income or loss that is, or is treated as, effectively connected with the conduct of a trade or business within the United States shall be treated as a separate QBU, provided the books and records requirement is satisfied.
For purposes of this section, books and records include books and records used to determine income or loss that is, or is treated as, effectively connected with the conduct of a trade or business within the United States.
Example 1. W is a domestic corporation that manufactures product X in the United States for sale worldwide. All of W’s sales functions are conducted exclusively in the United States. W employs individual Q to work in France. Q’s sole function is to act as a courier to deliver sales documents to customers in France. With respect to Q’s activities in France, a separate set of books and records is maintained. Q’s activities in France do not constitute a QBU since they are merely ancillary to W’s manufacturing and selling business. Q is not considered to have a QBU because an individual’s activities as an employee are not considered to constitute a trade or business of the individual.
Example 2. The facts are the same as in example (a) except that the courier function is the sole activity of a wholly-owned French subsidiary of W. Under paragraph (b)(2)(i) of this section, the French subsidiary is considered to be a QBU.
Conclusion
A determination of whether an activity in a foreign location constitutes a foreign branch for U.S. tax purposes requires an analysis of the facts and circumstances of each individual case.
Lynn K. Ching is a partner and one of the attorneys at Diosdi Ching & Liu, LLP, located in San Francisco, California. Lynn may be reached at (415) 318-3990 or by email at lching@sftaxcounsel.com.
This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.