The branch profits tax was implemented to subject the income earned by foreign corporations operating in the United States to two levels of taxation like income earned and distributed by domestic corporations. Under the branch profits regime, income is taxed at a maximum marginal rate of 35 percent when it is earned, and an additional 30 percent branch profits tax is imposed when the income is repatriated to the foreign headquarters. These two taxes correlate to the tax imposed on domestic corporations when income is earned and the tax on shareholders when income is distributed i.e. through dividends. If the foreign corporations effectively connected earnings and profits are invested in qualified U.S. assets, the amount on which the branch profits taxed is decreased because in essence the income is not being repatriated.
Along with the branch profits tax on repatriated earnings, the code also imposes a 30 percent tax on interest paid or deemed paid by a branch of a foreign corporation engaged in a US trade or business. Without this tax it would be possible for foreign corporations to avoid the branch profits tax altogether by making interest payments to foreign investors directly because interest payments by a foreign corporations would likely be foreign source income not subject to a 30 percent tax.
The branch profits is calculated by first determining the dividend equivalent amount for the year. This is generally defined as the corporation’s after-tax net ECI that is not reinvested in a U.S. business (and thus is treated as though the funds were repatriated. The dividend equivalent amount is then subject to a U.S. branch profits tax of 30%.
To determine the net ECI that has been repatriated, the foreign corporations net equity in the U.S. is analyzed (U.S. assets minus U.S. liabilities) to see if it has increased or decreased over the taxable year. U.S. assets include the adjusted basis of all property that has or expectedly could produce ECI plus cash on hand. U.S. liabilities include all effectively connected liabilities. If U.S. net equity increased during the year, the corporation is deemed to have reinvested in U.S. assets a portion of its current-year net ECI equal to the increase in net equity and this portion escapes the branch profits tax. If the net equity decreases during the tax year, taking into consideration the current years reinvested net after tax ECI, the net decrease deemed to have been repatriated is subjected to the branch profit tax. Simply shifting active U.S. business assets to passive investments within the United States will trigger the branch profits tax.
Determining The Branch Profits Tax
Foreign Corporation’s Exposure to Branch Profits Tax