Australian Expats Living In The USA: Understanding Your Capital Gains Tax Obligations

John Marcarian   |   30 Sep 2024   |   9 min read

Whether you have already moved to the United States or are planning to, there are tax implications for Australian expats to consider. 

For example, how does the Australia-US tax treaty apply to capital gains on the realization of assets, and what will your Australian and US tax obligations be? 

These are just a few questions this article will answer for you.

What Is Capital Gains Tax?

To begin, it is crucial to have a comprehensive understanding of capital gains tax concerning Australian expats. 

Capital Gains Tax or CGT is a tax on the profit made from selling an item classified as an asset. In Australia, as in the United States, CGT is complex and different from other taxes. Let us review both Australian and US CGT and then bring them together.

Australian CGT Tax

In Australia, CGT applies to any asset acquired after 20 September 1985. 

Selling an asset for more than it costs means you have a capital gain and must pay CGT. If an asset is sold for less than it cost, this results in a capital loss that can offset against current or future capital gains.

Generally, if an Australian tax resident makes a capital gain and the asset sold was held for at least 12 months, the 50% capital gain tax discount will apply. This results in half the capital gain being included in assessable income and being assessed at marginal rates of tax – which may vary between financial years. See the ATO website for the current individual tax rates. 

There are potential exemptions from the capital gains tax regime, including the main residence exemption.

A person’s main residence, which was moved into as soon as practicable after purchase and continues to be a person’s main residence for the entire ownership period, and on sale, if still a tax resident of Australia, will be exempt from CGT.

In relation to the main residence exemption, new laws passed in 2019, which came into effect 1 July 2020 now mean a total loss of this exemption if the property is sold while the taxpayer is a non-resident of Australia. There are some exceptions known as life events but careful planning is required to ensure the preservation of this exemption.

US CGT Tax

Under US law, the tax rate applied to capital gains depends on the asset’s holding period.

For assets held more than a year, you pay long-term capital gains tax, usually lower than the tax on ordinary income.

For assets held for less than a year, short-term capital gains tax rates apply, equal to your normal income tax rate.

Your income also determines the percentage of CGT you pay in the United States.

Your US CGT rate will depend on your taxable income. It is best to check the IRS website for the most current income thresholds for which CGT rate applies. 

There are also special circumstances under which your capital gains might be taxed at a higher rate. For example, net capital gains from selling collectibles (such as coins or art) are taxed at a maximum 28% rate.

Australia-US Tax Treaty And Its Impact On Capital Gains Tax

For Australian expats in the US, the Australia-US Tax Treaty is particularly important to understand. First signed into law in 1982, the treaty has been updated several times since then to address changes in areas such as superannuation and non-US investments.  

The Australia-US Tax Treaty determines where your tax obligations lie between the two countries. The overarching goal of the treaty is “avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income.” 

As we explain in this article, the Australia-US Tax Treaty, allows the tax paid in one jurisdiction to be claimed as a tax credit in the other jurisdiction, in the event that the income is assessable in both.  

For example, if the US sourced income is first taxed in the US and the income is then assessed in Australia, the tax first paid in the US will be taken up as a foreign tax credit against the tax assessed on the income. If the foreign tax credit covers the Australian tax, then any excess foreign tax credits are lost. If there is a shortfall after the foreign tax credit is applied to the assessed Australian tax, then extra tax will be required to be paid.

Tax Obligations When Selling A Former Main Residence In Australia

Let us look at an example to demonstrate how the Australia-US Tax Treaty affects Australian expats when selling their former main residence. 

An Australian couple moves to the US and lives there for eight years. They have decided to sell their former main home in Australia (purchased in 2015 for AUD1,000,000 and now worth AUD3,000,000).

Australian Tax Considerations

This couple would be classified as foreign residents and would not qualify for the CGT main residence exemption. As such, they will pay Australian CGT tax on the AUD2,000,000 (AUD3,000,000-AUD1,000,000) capital gain. 

However, if this Australian couple moves back to Australia and are considered residents for tax purposes and they reestablish the home as their main residence, depending on the length of their absence from Australia and whether they rented the property out or left it vacant, will determine whether a full or partial main residence exemption exists.

This example makes it clear that planning the timing of the sale of your former primary residence can and will have material tax implications. With that in mind, it is critical to get professional tax advice to optimize any potential or upcoming CGT liabilities.

It is important to note Australia also offers certain life event exemptions if they occurred during the time this family lived abroad, which could make them eligible for the CGT main residence exemption. 

The life events this includes are:

  • You, your spouse, or your child under 18 had a terminal medical condition
  • Your spouse or your child under 18 died
  • The CGT event happened because of a formal agreement following the breakdown of your marriage or relationship

USA Tax Considerations

Any income earned, including employment income and realized capital gains, is subject to US tax. Australians who have become US tax residents, including green card holders and those in the US for over 183 days in the last two years, are taxed on worldwide income. This would include the AUD2,000,000 capital gain.

However, the U.S. allows a foreign tax credit for U.S. residents on US taxes owed against any tax already paid to Australia or vice versa. 

The Australia-US Tax Treaty requires that the combined taxes paid in both countries cannot exceed the total tax that would otherwise have been payable in the country where the sale occurs.

Australia And USA Combined Tax Considerations

If the Australian couple decided to sell their former main residence in Australia while being a non-resident for tax purposes, they will need to declare this income on both the Australian and US income tax return. 

As the property is situated in Australia, the first taxing rights reside with Australia. Tax will be applied at non-resident marginal rates on their AUD2,000,000 capital gain.  

For the US CGT, the tax on their AUD2,000,000 capital gain would be calculated depending on their combined income and the CGT rate applicable. 

Thankfully, this couple would not have to pay both the full amount of tax in Australia and the US, as the tax treaty allows taxpayers in each jurisdiction to avoid double taxation. In this case as Australia has the first taxing rights, the US would give the couple a tax credit for the tax paid in Australia and the excess tax paid will be carried forward.

CGT On Selling Shares Originally Purchased In Australia

Let us assume an Australian citizen moves to the US for a period of five years. During this time, they decided to sell the shares purchased while they resided in Australia.

The first aspect to consider is what their choice was when then became a non-resident of Australia. If an Australian tax resident moves to the US and becomes a non-resident and they hold a share portfolio, the choices on cessation of residency with respect to the share portfolio is either to take a deemed disposal or ignore the deemed disposal and treat the shares as Taxable Australian Property. 

A deemed disposal involves comparing the purchase price of the shares to the market value of the shares on the date that residency ceased. Importantly, there is no cash received with respect to this type of CGT happening and so if there is a large accumulated capital gain, then there will be a tax bill that requires payment from other funds. 

If the latter option is chosen (ie. they choose to treat the shares as Taxable Australian Property), any future sale of these shares are connected with Australia and a capital gain or capital loss requires calculation and reporting in the Australian income tax return, even as a non-resident.

Fortunately, the treaty provides a paragraph where future sales of this portfolio can be subject to tax solely in the US. If a choice is made to have future sales subject to tax solely in the US, then the deemed disposal on cessation of residency is ignored.

CGT On Inheritance In Australia

If an Australian citizen has lived in the US for 15 years and inherits an investment property and shares, what are the tax implications in both Australia and the US?

Inheriting Property

The original property was purchased for AUD500,000 and has a current market value of AUD2,500,000. If the property was sold on when inherited, there will be a capital gain of AUD2,000,000 (AUD2,500,000-AUD500,000). As Australia has the first taxing rights, tax will be applied at non-resident rates.

If they had no other Australian sourced income for the year in which the property was sold, tax on the capital gain of AUD2,000,000 would be AUD875,350.

The USA CGT tax on their AUD2,000,000 capital gain would be calculated depending on their combined income and the CGT rate applicable.

The Australian citizen would not have to pay both the AUD875,350 Australian CGT and US CGT as the treaty allows taxpayers in each jurisdiction to avoid double taxation. In this case, the US would give the person a tax credit totaling AUD875,350.

Inheriting Shares

If they inherit shares, they can choose to have any future sales solely taxed in the US under the Australia-US Treaty.

Get Help Navigating CGT For Australian Expats

There are many intricacies and challenges to navigating tax laws between countries. The information in this article may not cover some variables relevant to your circumstances and as such it is recommended you seek tax advice for your specific situation.

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FBAR Violations And Recklessness: What You Need To Know To Avoid Hefty Penalties


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FBAR Violations And Recklessness: What You Need To Know To Avoid Hefty Penalties

John Marcarian   |   9 Sep 2024   |   6 min read

The U.S. government’s crackdown on offshore tax evasion has placed the Report of Foreign Bank and Financial Accounts (FBAR) in the spotlight. Many U.S. taxpayers with foreign accounts may not fully understand their obligation to disclose these accounts, and even fewer realize the severe penalties that come with failing to comply. For U.S. citizens, residents, and entities with foreign financial accounts, the stakes are high.

Understanding FBAR requirements and the line between non-willful and willful violations, including recklessness, can mean the difference between a reasonable penalty or a financial disaster. A key case illustrating this legal battlefield is Bedrosian v. United States, a cautionary tale for those who might be unaware—or choose to remain unaware—of their filing obligations.

FBAR Reporting Requirements And Penalties: An Overview

U.S. citizens, residents, and certain entities are required to file an FBAR if the aggregate value of their foreign accounts exceeds $10,000 at any point during the calendar year. This requirement applies even if the accounts don’t generate taxable income. The FBAR is filed annually with FinCEN, separate from tax returns.

Penalties for failing to comply are steep:

  • Non-Willful Violations: Penalties for non-willful violations are generally capped at $10,000 per violation unless the taxpayer can show reasonable cause.
  • Willful Violations: For willful violations, penalties can be far more significant, often up to 50% of the account balance or $100,000, whichever is greater. In some cases, criminal charges can also be brought.

The difference between willful and non-willful violations is central to determining penalties, and recent court cases and IRS guidance have clarified that recklessness can meet the standard for willful conduct.

Bedrosian Case: Recklessness Redefined

In Bedrosian v. United States, the issue of recklessness in the context of FBAR penalties took center stage. Arthur Bedrosian, a successful businessman from Pennsylvania, had held foreign accounts with UBS in Switzerland. Despite being aware of his FBAR obligations, he failed to report one of his accounts in 2007. The IRS imposed a $975,789 penalty, citing willful failure to file.

Initially, the district court sided with Bedrosian, ruling that his actions were non-willful, and reduced the penalty to $10,000. However, on appeal, the 3rd Circuit Court found that the district court had applied an incorrect standard of willfulness, specifically underestimating the role of recklessness in FBAR violations. The 3rd Circuit clarified that recklessness can indeed qualify as willfulness, and remanded the case for further review. Upon reconsideration, the district court determined that Bedrosian’s failure to report the account demonstrated at least reckless disregard, and the original penalty was reinstated.

Key Case On Recklessness: McBride And FBAR Penalties

A landmark case discussing recklessness in FBAR violations is United States v. McBride. In this case, the taxpayer, Michael McBride, failed to file an FBAR for his offshore accounts. The court found that McBride acted with reckless disregard of the filing requirements, even though he claimed ignorance. The court emphasized that recklessness could be inferred from a taxpayer’s knowledge of the law and his failure to comply with it, even if there wasn’t a clear intent to break the law.

The McBride decision underscored that a taxpayer doesn’t need to knowingly violate FBAR obligations to be penalized severely. Acting recklessly—such as choosing not to learn the rules or ignoring clear indications that filing is required—can be sufficient to trigger the harshest penalties.

IRS’s Approach To Determining Willfulness: The Role Of Evidence

The IRS takes a broad approach when assessing whether an FBAR violation was willful or reckless. In doing so, the agency looks at various forms of evidence to determine whether a taxpayer’s failure to file was due to deliberate intent, recklessness, or negligence. Key factors include:

  • Prior Filings And Disclosures: The IRS may review past tax returns and FBAR filings to assess whether the taxpayer has consistently disclosed foreign accounts. A pattern of non-disclosure could suggest willfulness.
  • Foreign Bank Communications: Correspondence between the taxpayer and their foreign bank can provide clues about willfulness. For instance, if the bank warned the taxpayer about FBAR requirements, and they still failed to comply, this could indicate recklessness.
  • Education and Background Of The Taxpayer: The IRS will also take into account the taxpayer’s background and sophistication. For instance, someone with a high level of financial literacy, such as a business owner or an individual working in finance, is more likely to be held to a higher standard of knowledge regarding their obligations. In Bedrosian, for example, his years of financial dealings and awareness of offshore accounts contributed to the court’s determination of recklessness.
  • Taxpayer Behavior: Deliberate concealment, such as moving funds to different jurisdictions or closing accounts after learning of an investigation, can be viewed as willful.

The Internal Revenue Manual also provides guidelines for IRS examiners to follow when assessing willfulness. The IRS is particularly focused on patterns of behavior that demonstrate a conscious choice to disregard the law.

What Does This Mean For Taxpayers?

Taxpayers who hold foreign accounts must be aware of the serious consequences of failing to comply with FBAR requirements. The distinction between willful and non-willful violations is often determined by the taxpayer’s behavior and the totality of the circumstances, not just their direct knowledge of the law. The IRS will scrutinize the individual’s past filings, communications, and behavior to determine whether their failure to file was reckless or deliberate.

As seen in McBride and Bedrosian, recklessness doesn’t require overt intent to evade the law. Simply failing to act on information, or ignoring a known legal duty, can lead to penalties amounting to 50% of the account balance. The IRS’s focus on recklessness means that taxpayers cannot afford to be passive about their foreign accounts. They must actively ensure compliance or risk facing substantial financial penalties.

Conclusion

With the growing focus on offshore tax evasion, the U.S. government has ramped up its enforcement of FBAR penalties. The Bedrosian and McBride cases highlight the importance of understanding the broad definition of willfulness, which includes reckless conduct. Taxpayers who fail to disclose foreign accounts may face severe penalties, even if they claim ignorance. Staying informed and seeking expert advice is critical for anyone with international financial interests.

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John Marcarian   |   20 Aug 2024   |   4 min read

Declaring Foreign Business Interests

Navigating the U.S. tax code can feel like tiptoeing through a minefield, especially when you throw in international dealings. 

If you’re a U.S. person or corporation with foreign business interests, two forms in particular—Forms 5471 and 5472—might already haunt your dreams. 

Dubbed the “Terrible Twosome” by some beleaguered taxpayers, these forms come with stringent filing requirements and draconian penalties for non-compliance. 

Here’s why you should never forget to file these forms, what the consequences of forgetting are, and some recent developments that might surprise you.

What Are Forms 5471 And 5472?

Form 5471 is essentially an information return that must be filed by certain U.S. citizens and residents who are officers, directors, or shareholders in certain foreign corporations. 

The form requires detailed disclosure about the foreign corporation’s income, assets, and shareholders.

Form 5472 on the other hand, is used by U.S. corporations that are at least 25% foreign-owned, or by foreign corporations engaged in a U.S. trade or business. 

This form requires disclosure of reportable transactions between the reporting corporation and related foreign parties.

While both forms may seem like just another piece of paperwork, failure to file them—or filing them incorrectly—can lead to massive penalties.

The Fines:

Staggering and Unforgiving The IRS takes non-compliance with Forms 5471 and 5472 very seriously, with penalties that could make even the most seasoned tax veteran wince. 

For Form 5471 the penalty starts at $10,000 per year per foreign corporation. 

If the taxpayer fails to correct the omission within 90 days of being notified by the IRS, additional penalties of $10,000 accrue every 30 days, up to a maximum of $50,000. 

Form 5472 penalties are even harsher, starting at $25,000 for each accounting period the form is not filed. 

After the IRS sends a notice of failure, an additional $25,000 penalty kicks in for each subsequent 30-day period of non-compliance, with no cap on the penalties. 

These penalties apply whether the non-compliance was willful or due to an innocent mistake, although options for relief exist in cases of non-willful conduct. 

However, this relief is often difficult to obtain and requires demonstrating reasonable cause for the failure. 

No Statute Of Limitations? Yes, You Read That Right

One of the most terrifying aspects of failing to file these forms is that it can leave your entire tax return open to scrutiny indefinitely. 

Normally, the IRS has three years from the date you file your return to audit it. 

However, if you fail to file Forms 5471 or 5472, that statute of limitations does not apply. The IRS could theoretically go back and audit that return 10, 15, or 20 years later. 

Recent Developments: A Small Ray of Hope?

A recent Tax Court case, Farhy v. Commissioner, had thrown a wrench into the IRS’s penalty regime. 

In April 2023, the court ruled that the IRS did not have the statutory authority to assess penalties under Section 6038(b) for failing to file Form 5471. 

The IRS had been enforcing these penalties for years, but the court found that there was no legal basis for these assessments.

However this Tax Court Ruling was subsequently overturned by the United States Court of Appeals, District of Columbia Circuit on  3 May 2024.

Conclusion: Don’t Tempt Fate

If you have foreign business interests and think you might need to file Form 5471 or 5472, the best advice is simple: file them. 

Even if the forms are a headache and the rules seem complex, the potential costs of non-compliance—financial and otherwise—are simply too high to ignore. 

And as the Farhy case shows, while there may be occasional victories against the IRS, they are the exception rather than the rule. 

So, stay vigilant, keep those forms in mind, and avoid becoming another cautionary tale in the annals of tax non-compliance. 

The “Terrible Twosome” might be formidable, but with careful attention and professional guidance, they don’t have to be your undoing.

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John Marcarian   |   29 Jul 2024   |   5 min read

For many people the United States is a major investment jurisdiction.

Whether that investment is made into stocks, bonds, managed funds, real estate or shares in US private companies – the size and scale of the US market is often irresistible for international investors.

One of the downsides of investing directly into the US can be that non-residents of the United States who own U.S. assets can be subject to U.S. estate tax.

This can significantly impact their estate planning strategies by imposing a significant cost on their estate.

This article discusses the exposure of non-residents to U.S. estate tax, the benefits of estate tax treaties, the relevance of international wealth in estate tax calculations, and the formalities required to transfer U.S. assets to beneficiaries. 

U.S. Estate Tax for Non-Residents

Non-residents of the U.S. are subject to estate tax on their U.S. situs assets, which include real estate, tangible personal property located in the U.S., and certain intangible assets such as stocks of U.S. corporations. 

The tax rates range from 18% to 40%.

Importantly the exemption amount is significantly lower for non-residents than for U.S. citizens and residents, currently only $60,000.

Estate Tax Treaties

The U.S. has estate tax treaties with several countries, including Australia, Canada, France, Germany, Italy, Japan, the Netherlands, South Africa, Switzerland, and the United Kingdom. 

These treaties can provide several benefits, including:

Unified Credit

Some treaties allow non-residents to use the unified credit available to U.S. citizens, which can significantly reduce the estate tax liability. 

Exclusions And Deductions:

Treaties may provide for exclusions of certain types of property or deductions for debts, taxes, and expenses.

Relief From Double Taxation:

Treaties can prevent double taxation by providing rules for the allocation of taxing rights between the U.S. and the treaty country.

Relevance Of International Wealth

For non-residents, the U.S. estate tax is generally limited to U.S. situs assets.  

However, the international wealth of foreigners can still be relevant in certain situations.

For example, under some treaties, the U.S. may consider the decedent’s worldwide assets to determine the allowable unified credit or to apply pro-rata deductions. 

Example Calculation (Singapore Resident: No Estate Tax Treaty With US)

The non-resident owns a $1,000,000 U.S. property and has no debts or other deductions: 

1. Gross Estate: $1,000,000 (U.S. property) 

2. Exemption Amount: $60,000 

3. Taxable Estate: $940,000 

Using the U.S. estate tax rates, the estate tax liability would be calculated based on the progressive rates. 

For simplicity, assume the effective tax rate is around 34% for this taxable estate size: 

Estate Tax Due: $940,000 x 34% = $319,600

This is major cost on a deceased estate and something that can be planned for ahead of time.

They key point here is to be aware of strategies to minimize or eliminate US estate tax.

Example Calculation (Australian Resident: Estate Tax Treaty With US)

The U.S.- Australia Estate Tax Treaty can provide relief and reduce the tax liability. 

Consider an Australian resident who owns a $1,000,000 U.S. property and has $5,000,000 in worldwide assets. 

The unified credit for U.S. citizens in 2024 is $13,000,000. 

1. Gross Estate: $1,000,000 (U.S. property) 

2. Worldwide Estate: $6,000,000 

The proration of the unified credit is calculated as follows: 

Prorated Unified Credit = U.S. Situs Assets/Worldwide Assets  X Unified Credit

Prorated Unified Credit = 1,000,000/6,000,000 x 13,000,000 = 2,166,66 

The effective exemption amount is $2,166,667. 

 3. Taxable Estate: 

Since the U.S. situs assets ($1,000,000) are less than the prorated unified credit ($2,166,667), the taxable estate is reduced to zero. 

 4. Estate Tax Due: 

 With a taxable estate of zero, the estate tax liability is also zero.

Formalities For Transferring U.S. Assets

For those beneficiaries of deceased estates that have to deal with the transfer of U.S. assets from a deceased resident to a beneficiary, the following steps are required:  

1. Obtain A Transfer Certificate: 

The IRS requires a Transfer Certificate (Form 5173) to release the U.S. assets. 

This certificate ensures that all applicable estate taxes have been paid or secured. 

2. File Form 706-NA: 

The executor must file Form 706-NA, U.S. Estate (and Generation-Skipping Transfer) Tax Return, to report the U.S. situs assets and calculate the estate tax due. 

3. Pay Estate Tax: 

Any estate tax due must be paid. 

In the above examples, in Singapore the estate tax due is $319,600. Whereas in the case of the Australian estate no tax is due. 

4. Submit Documentation: 

Provide the IRS with necessary documentation, including the death certificate, will or trust documents, and appraisals of the U.S. assets. 

 5. Transfer of Title: 

Once the Transfer Certificate is obtained, the executor can proceed with the transfer of title of the U.S. assets to the beneficiaries as per the deceased’s will or trust documents. 

Conclusion

Other strategies exist to manage this exposure, including the formation of trusts in certain US states to hold assets.

The key point here is to plan the way you hold your U.S. assets as early as you can.

Indeed, those people who are non-residents of the U.S. holding US assets from countries that do not have an Estate Tax Treaty with the U.S. have the most severe exposure.

Please contact us to discuss any concerns or questions you might have with respect to holding US assets.

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Understanding Section 962 of the IRC: An Essential Tool for U.S. Tax Residents with Foreign Investments

John Marcarian   |   30 May 2024   |   5 min read

The United States tax code presents a labyrinth of rules and regulations, particularly for U.S. residents with investments in foreign corporations. These complexities are magnified when dealing with Controlled Foreign Corporations (CFCs) and the associated immediate taxation of foreign earnings under Subpart F or the Global Intangible Low-Taxed Income (GILTI) regime. This article delves into Section 962 of the Internal Revenue Code (IRC), explaining its significance and utility for U.S. tax residents in managing their foreign investments more effectively.

The Challenge: Immediate Taxation of Foreign Earnings

For U.S. tax residents with investments in foreign corporations, including those held through pass-through entities such as partnerships and S corporations, immediate taxation of foreign earnings is a significant challenge. This taxation arises annually under the Subpart F or GILTI regimes, compelling taxpayers to include foreign income in their U.S. taxable income, often leading to double taxation without relief mechanisms available to corporate taxpayers.

Corporate vs. Individual Taxpayer Treatment

The tax burden disparity between corporate and individual taxpayers under the GILTI regime is stark. U.S. corporations benefit from a reduced federal income tax rate of 21 percent, a Section 250 deduction that allows them to deduct up to 50 percent of GILTI, and the ability to claim up to 80 percent of foreign taxes paid as a foreign tax credit. This combination of benefits significantly mitigates the impact of GILTI on corporate taxpayers.

Conversely, U.S. resident individuals are generally taxed at a federal income tax rate of up to 37 percent on GILTI, without access to the Section 250 deduction or foreign tax credits for GILTI. This discrepancy creates a substantial tax burden for individual taxpayers, necessitating a strategy to level the playing field. This is where Section 962 of the IRC comes into play.

How Section 962 Election Works

A Section 962 election allows U.S. individuals to elect to be taxed on their GILTI and Subpart F income at corporate tax rates. When an individual makes this election, they are effectively treated as if they own their CFC through a hypothetical domestic corporation. This election provides several advantages:

  1. Corporate Tax Rate: The taxpayer is subject to the 21 percent corporate tax rate instead of the higher individual rates.
  2. Section 250 Deduction: The taxpayer can avail the Section 250 deduction, reducing GILTI by 50 percent.
  3. Foreign Tax Credit: The taxpayer can claim an indirect foreign tax credit for taxes paid on the CFC’s net income in the foreign country, up to 80 percent of the foreign taxes paid.

Practical Example Of Section 962 Election

Consider a U.S. individual who wholly owns a CFC in Germany with net tested income of $1,000 for GILTI purposes, having paid $150 in foreign taxes. Without a Section 962 election, the individual faces a 37 percent tax rate on GILTI, resulting in $370 of U.S. tax, without any foreign tax credit or Section 250 deduction.

However, with a Section 962 election:

  • The income is taxed at the corporate rate of 21 percent.
  • The individual can deduct 50 percent of the GILTI under Section 250, reducing the taxable income to $500.
  • Adding back the $150 foreign tax paid (gross-up), the taxable income becomes $650.
  • Applying the 21 percent corporate tax rate results in $136.50 of U.S. tax.
  • After claiming 80 percent of the $150 foreign tax as a credit ($120), the U.S. tax liability is reduced to $16.50.

Future Distributions And Tax Implications

The tax advantages of a Section 962 election extend to future distributions. In the example above, when the taxpayer eventually receives a distribution of $1,000 from the CFC, it will be taxed at the qualified dividend rate of 20 percent plus the 3.8 percent Net Investment Income Tax (NIIT), resulting in $238 of U.S. tax. Without the election, distributions would typically be subject to ordinary income tax rates, leading to higher tax liabilities.

When To Make A Section 962 Election

Despite its benefits, a Section 962 election is not always advantageous. Some scenarios where the election might not be beneficial include:

  1. Same-Year Repatriation: If the CFC’s earnings are repatriated in the same year, the benefits of the election may be negated.
  2. State Tax Considerations: Not all states follow the federal tax treatment. States like California do not tax Subpart F or GILTI until a distribution is made, meaning the Section 250 deduction and foreign tax credits may not be available for state tax purposes.
  3. Future Tax Increases: Future distributions from previously taxed earnings under a Section 962 election might be taxed at higher rates, potentially offsetting the initial benefits.

Conclusion

Section 962 of the IRC offers a powerful tool for U.S. tax residents with investments in foreign corporations to manage their tax liabilities more effectively. By allowing individuals to be taxed at corporate rates and claim deductions and credits typically available only to corporations, this election can significantly reduce the tax burden associated with GILTI and Subpart F income. However, the decision to make a Section 962 election should be based on a careful analysis of individual circumstances and potential future implications. Consulting with a tax professional is essential to navigate the complexities and determine the best tax strategy.

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Expanding To Dubai: What You Need To Know When You Are Ready To Expand Your Business

John Marcarian   |   31 Aug 2023   |   8 min read

Planning a move overseas is a big step, no matter where you are going. There are different social expectations, legal rules, business regulations, tax requirements, and more to figure out.

You need to determine whether you or a key team member is going to make the physical move to head up the overseas expansion, and facilitate this move to be as smooth and efficient as possible. 

Then there are business decisions such as deciding whether to set up a brand-new company, or trade overseas directly under your head company. While there are too many factors to consider in one article, and it is essential to get tailored advice for your situation, you can get a head start by considering an overview of the key concepts that you will need to cover.

1. Operation Zones

Companies in Dubai can choose to operate as free zone companies, offshore companies, or Mainland companies. This decision will have an impact on where you can do business.

If Dubai is going to be your hub for regional or international commerce, then a free zone entity may be the best option. This is because Free Zone Companies can only operate within their Free Zone and abroad, not on the mainland. However, if you are intending to provide goods and services to the UAE, then a Mainland firm would be the required option.

Free Trade Zone Company

There are over 40 zones throughout the UAE that are Free Trade Zones. These zones have special tax, customs, and import regimes. Businesses operating within these Free Trade Zones may be exempt from paying corporate tax as well as import and export taxes. However, they are restricted from doing business with the Mainland.

Mainland

A Mainland business can be set up in Dubai or any other emirates, so they can operate in the UAE as well as internationally.

Offshore Company

If your company is incorporated in the UAE offshore, you can operate with minimal capital requirements and operate on an international basis.

2. Income Taxes

From June 2023 all companies operating in the UAE under a commercial licence are taxed after the first 375,000 AED of their net profits. The tax is charged at a flat rate of 9% and only applies to the profits above this first 375,000 AED. This makes it one of the more appealing corporate tax rates in the world.

Note that Free Trade Zone companies may continue to be exempt from paying corporate tax under their specific free zone incentives. 

In line with the Global Minimum Corporate Tax Rate agreement, multinational firms with profits exceeding EUR 750 million, will have to pay 15% tax. 

From June 2023 businesses operating under the new rules now need to register with the Federal Tax Authority and lodge tax returns for the business on an annual basis.

3. VAT and Excise Tax

Since 2018 a goods and services tax, or a value-add tax, known as VAT, has been applicable at a flat rate of 5%.

There are some exclusions to which items incur VAT, including exports of goods and services, international transportation, some education and healthcare services, investment-grade precious metals, and new construction of residential properties. Some Free Trade Zeons are also exempt from paying VAT for trade within their zones. 

In 2017 the UAE implemented an excise tax. This is an indirect tax that is imposed on goods that are considered to be harmful to either personal health or the environment. This includes a 50% tax on carbonated drinks and a 100% tax on energy drinks and tobacco products.

4. Employer Responsibilities

As an employer you are responsible for paying your employees under the local employment rules and regulations. There are a range of responsibilities that you are required to cover for your employees, including:

  • Paying wages in accordance with local laws and regulations. This includes proper job documentation, conditions of labour, and paying wages on time. As there is no individual income tax there is no tax withholding regime to consider.
  • Providing health insurance for employees. This is a compulsory requirement for all employers.
  • Under UAE law the employer is responsible for paying the travel and recruitment costs, including entry visa, of any employee they are recruiting or moving to the UAE.

5. Moving To Dubai When Expanding Your Business

A visa residency through employment is required for any individual moving to Dubai for work purposes. Note that it is the employer’s responsibility to organise and pay for an employment Visa.

The standard work Visa lasts for two years. This requires an employer sponsor to confirm employment in Dubai.  

A “Green Visa” is applicable for freelancers or self-employed individuals. This requires specialised educational qualifications and evidence of your annual income to prove financial solvency. This Visa is for five years.

Finally, the “Golden Visa” is a residency permit that allows foreigners to live, work, or study in the UAE for 10 years without a sponsor. Investors, entrepreneurs, and more can apply for this Visa. This Visa also allows the immediate family to be sponsored so they can move to Dubai as well.

It is also important that individuals moving to Dubai are aware of local expectations, laws, and requirements, which may be vastly different from your home country.

6. Other Business Responsibilities

As with running a business in any other location, there are essential rules, regulations, licensing, and other requirements that your business needs to be aware of as part of your setup and operation.  Some of these are listed below.

Bank Account

It can take two to four weeks to open a bank account for commercial purposes. While the required documents vary according to the bank and the type of account you open, the Business Manager will need to have their own residency visa in order before you apply.

Trade Licence

Every business that operates in the UAE must have a trade licence, or a business licence. This may be a commercial licence, a professional licence, or an industrial licence, depending on your business activity.

Business Entity

You can set up your business as a sole proprietorship, an LLC company, or a branch office. If operating from a Free Trade Zone your business can be 100% foreign-owned.

7. Double Tax Agreements (DTAs)

The UAE is expanding their list of DTAs throughout the countries of the world in order to facilitate strategic global partnerships. These agreements help ensure that the consequences of being taxed in multiple tax jurisdictions is mitigated via exemptions or reductions in taxation on investments from profits.

While the USA does not have a DTA with the UAE, there is currently a DTA between the UAE and Singapore, as well as the UAE and the UK. Australia is in the process of establishing a DTA with the UAE. 

8. Property Taxes

Although there is no capital gains tax or inheritance tax in the UAE, there is a transfer charge on the transfer of property within the UAE. The rate of charge varies in each Emirate, with a 4% charge applying in Dubai. This transfer fee is typically paid by the buyer of the property.

9. Rental Tax

Although there is no individual income tax in Dubai, there is a rental tax. The tax on rental properties varies between Emirates. In Dubai commercial tenants pay 10% and residential tenants pay 5%. In some locations citizens are exempt from the rental tax.

Foreigners In The UAE

As there is no income tax for individuals, both residents and non-residents of the UAE are not required to lodge an income tax return in the UAE.

However, if you remain a resident of your home country then you will need to lodge a tax return in your country of residence, and this may require the inclusion of income earned from the UAE.

Depending on how your business in the UAE is set up, you may also be required to report this income as foreign income in a local company tax return.

Local Taxation Experts

As there is no individual income tax and corporate tax is new to the UAE, there may be limited access to accountants, and limited experience with the UAE tax regime on a local level.  

It is therefore especially important to seek the advice of International Tax Experts who can help you navigate the new requirements in Dubai, as well as the impact of doing business across multiple borders.

CST have been assisting Australian and expat clients for over 30 years. Helping businesses to set up overseas and connect with local tax experts is an essential part of the support we offer clients around the globe. With the UAE now introducing a corporate tax into their tax regime it is more important than ever that you get the right advice for your expansion into Dubai. 

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Dubai: A Popular Choice For Expanding Your Business


28th Jul 2023
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Dubai: A Popular Choice For Expanding Your Business


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In today’s world we have incredible opportunities to build our business beyond our own shores and reach into expansive international markets...

Dubai: A Popular Choice For Expanding Your Business

John Marcarian   |   28 Jul 2023   |   4 min read

In today’s world we have incredible opportunities to build our business beyond our own shores and reach into expansive international markets. Indeed, the number of expats is growing so fast that if all the expats were members of a country, it would be one of the fastest growing countries in the world.

The United Arab Emirates (UAE) is one of the most popular destinations for expats. As of 2023 the UAE is called home by approximately 10.2 million people. A staggering 85% of the individuals who comprise that population, are expats. When you look at why Dubai is an attractive market for businesses, it’s not hard to see why this temptation to join the shores of the UAE is hard to pass.

In this article we’ll look at the appeal of Dubai as a destination to expand your business to, and what you need to know when you’re ready to expand your business to Dubai.

The Appealing Business Market of Dubai

The simplified and diversified economy of Dubai makes it an attractive place to set up your international business. Some of the key reasons that Dubai is particularly appealing include:

1. Minimal Tax Regime In The UAE

One of the most appealing benefits of doing business in Dubai is a minimal tax regime. Company taxes are low and there is no income tax on individuals and no capital gains tax. 

2. Free Trade Zones

The UAE includes a number of Free Trade Zones, with about 20 located in Dubai. Free Trade Zones are geographical locations where people from any other country can come in and set up their international business, without requiring a local connection. Businesses located in Free Trade Zones can operate their business within their zone and internationally. Each Free Trade zone has their own rules, regulations and incentives. 

This differs from Mainland zones. Mainland Zones have more rigorous entry requirements, including local sponsorships, before your business can set up and operate. These Zones are regulated by the Department of Economic Development (DED). However, a business operating in a Mainland Zone is able to trade within the UAE, as well as internationally.

3. A Robust, Yet Simplified and Diversified Economy With A Strong Exchange Rate and Access To Resources

Balancing a safe and robust standard of governance, with minimal taxation responsibilities,       Dubai offers a world-class infrastructure and is well known as a world-class financial hub for business operations. The local economy is strong and the UAE has a solid exchange rate. 

As a popular location for expats around the world, there is also a rich and diverse supply of experience and professional skills on location. 

Furthermore, the local government is a strong advocate for developing ideas and facilitation of growth and progress. As a technologically advanced nation, Dubai also has access to significant beneficial resources.

4. Limited Restrictions and Regulations On Your Company

There is no restriction on capital repatriations. This means that your company can return any investments to foreign owners, without limitations. 

Share capital requirements are minimal, with no minimum amount of capital required for limited liability companies. This ensures that your company can be established with the flexibility to suit your purposes. 

Unlike many countries, there is no requirement to have a physical office established to operate in Dubai. 

Due to the minimal amount of regulations, when compared to other onshore jurisdictions the costs of setup in Dubai are low.

5. Geographically Ideal Location

Geographically, Dubai provides a strategic position for businesses looking to expand to the Middle East, Europe, Asia and Africa. As such it is an ideal location to set up a range of businesses including import/export, logistics, tourism, and more. 

For transportation, Dubai offers access to the largest sea and airports in the world.

6. Strong Connections With the Worldwide Economy and Worldwide Business Standards

The UAE has signed up with the Common Reporting Standard (CRS), as part of the global standard for the exchange of information, including allowing countries to exchange tax data between participants. This helps with the prevention of fraud, and aids in the management of business matters across international borders. 

In essence, Dubai is an appealing place to run a business because of the ease and convenience of doing business there, solid business standards, access to resources, and the simple and low tax regime that applies.

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Expanding To Dubai: What You Need To Know When You Are Ready To Expand Your Business


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